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Socially responsible investing is turning into a covert
war on fossil fuels
BY PAUL KUPIEC, OPINION CONTRIBUTOR — 03/11/22
THE VIEWS EXPRESSED BY CONTRIBUTORS ARE THEIR OWN AND NOT THE VIEW OF
THE HILL
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Once a practice rooted in religious
beliefs, socially responsible investing, or ESG investing
in today’s lexicon, is about to become a secular practice mandated by
the government.
The Biden administration’s push to require all publically-traded firms
to report their greenhouse gas emissions as a component of new public
disclosure requirements is a step toward making ESG investing
mandatory. In this new twist, the government will decide which firms
deserve access to investment capital. Mandatory reporting of
greenhouse gas emissions will lead to government regulations that will
curtail new capital investments in companies that produce or consume
fossil fuels.
With a United Nations endorsement,
the socially responsible investment fashion of the late 20th century
transitioned into the Environmental, Social and Governance movement or
ESG. Once a voluntary movement that prioritized investment in
companies that adopt policies and practices that promote the
progressive left’s environment, labor and human rights causes, ESG
investing is about to become a regulatory tool they will use to
achieve specific objectives.
Investor interest in voluntarily supporting companies that champion
specific nonprofit-oriented practices created incentives for
businesses to signal their ESG efforts in public disclosures. The
movement spawned an industry to provide ESG ratings that purportedly
assess a firm’s adherence with ESG-related climate change, labor and
governance policies. Investment managers use these ratings to identify
ESG-friendly companies. More recently, international pressures have
been building to standardize and mandate ESG disclosure. Last year,
the UN Climate Change Conference (COP26) established the International
Sustainability Standards Board (ISSB) to create
standards for companies to use when making periodic disclosures on ESG-related
issues.
The experience with voluntary ESG disclosures suggests that mandatory
disclosures alone are unlikely to produce progress on progressives’
agenda. Because voluntary company ESG disclosures and ESG rating have
not produced the left’s desired outcomes, further government measures
will be required.
The incongruence between ESG ratings and the progressive left’s agenda
is readily apparent. For example, a recent Bloomberg report analyzing
the ratings produced by MCSI Inc. found that they “don’t measure a
company’s impact on the Earth and society. In fact, they gauge the
opposite: The potential impact of the world on the company and its
shareholders.” Similarly, an analysis of
MSCI’s large bank ESG ratings found that many large banks received ESG
rating upgrades “in recognition of their environmental efforts”
despite the fact that they were among the banks most active in funding
the oil and gas industries.
The dissonance between ESG ratings and ESG goals is not limited to one
rating agency. According to the Dow Jones North American
Sustainability Index, Philips Morris gets a high
ESG rating despite the fact that it sells 700 billion
cigarettes a year. The irony is that the crusade to disinvest
‘big tobacco’ was one of the first organized campaigns of
the nascent ESG movement. Similarly, Alphabet, Amazon and Facebook
receive favorable ESG ratings while few socially responsible investors
would likely consider them good corporate citizens, given their
alleged monopolistic practices and their history of labor disputes.
The fuzzy link between ESG disclosures and agency ESG ratings is being
used to justify the standardization of ESG disclosures. But the move
to standardize and mandate ESG disclosures has another purpose. It is
the first step toward creating metrics regulatory agencies can use to
penalize public companies involved in politically disfavored
industries — most immediately, those that extract, refine or use
significant amounts of fossil fuels.
In the United States, the Securities and Exchange Commission (SEC) has
jurisdiction over rules regarding mandatory disclosures in securities
prospectuses and reoccurring public company reports. Since 2010,
SEC guidance regarding ESG-related disclosure is that ESG
considerations should be discussed when they represent a material
factor in the business description, risks, management outlook or legal
proceedings facing a company. The SEC is currently revisiting this
guidance and seems likely to require public companies and investment
funds to report on their ESG-related accomplishments in a standardized
format that includes disclosures on their greenhouse gas emissions
calculated using GHG
Protocols.
The plan to mandate disclosure of public companies’ greenhouse gas
emissions, while veiled as an initiative to improve public disclosure,
serves another policy goal of the Biden administration — restricting
fossil fuel-intensive industries’ access to investment capital. The
recent Financial Stability Oversight Council report found
that climate change poses a systemic risk to the financial sector.
Such a declaration empowers financial regulators to use Dodd-Frank
Act powers to identify and mitigate systemic threats to the
financial system.
Under authorities granted by the Dodd-Frank Act, new regulations can
be imposed to discourage investment in firms with high greenhouse gas
emissions using the justification that the regulations are needed to
reduce financial system systemic risk. Requiring public companies to
disclose their emissions is but the first step in a broader policy
agenda.
Regulations to discourage investments in high emissions firms could
take many forms once public firms are required to report them using
standardized methods. Regulators could impose higher bank regulatory
capital requirements for investments that fund firms with high
emissions. Alternatively, they could use supervisory stress tests with
extreme climate-change transition shocks to force banks to categorize
such firms as exceptionally large credit risks. They could impose
limits on the total greenhouse gas emissions in investment portfolios
and require credit rating agencies to downgrade securities linked with
high emissions. As Assistant Secretary of the Treasury for Financial
Institutions Graham Steele has written,
there are countless ways the data could be used to restrict
carbon-emitting firms from accessing investment capital.
Today, the option of investing in companies with ESG-friendly policies
is at risk of being transformed into a requirement that companies
prioritize the progressive left’s ESG goals over shareholder returns.
Not only are periodic ESG disclosures likely to become mandatory, but
the standardized data they will be required to provide will allow
regulators to penalize public companies involved in disfavored
industries including those that invest in, or make heavy use of,
fossil fuels.
Paul H. Kupiec is a senior fellow at the American
Enterprise Institute (AEI), where he studies systemic risk and the
management and regulations of banks and financial markets.
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