ESG: Capitalism Refocused or Run Amok? Depends Who You Ask

ESG Headshots

By Elizabeth Boucher Dawson, Crowell & Moring LLP
By Felicia Isaac, Crowell & Moring LLP

 

When the acronym "ESG" was coined two decades ago, the drafters may not have anticipated just how much their linking together three seemingly-disparate risk factors—environmental, social and governance—and asserting they should be incorporated into investment decision-making, would capture the corporate domain. Reflecting the heightened attention to stakeholder capitalism, ESG has provoked an acute debate in Congress, state governments and abroad. Emphasizing ESG is said to have the potential to catalyze corporate activity leading to better resiliency to existing and emerging risks from climate change to whistleblower claims, making companies more attractive to investors, lenders, insurers and customers. But such activities can also serve to alienate certain constituencies—most notably Republican state and federal politicians—requiring awareness of changing and sometimes conflicting rules, regulations and policies that seek to encourage or discourage ESG-related activities.

 

The Pro-ESG Movement

ESG proponents describe ESG as a stakeholder-centric framework used to evaluate an organization’s business practices and performance on a variety of sustainability factors, including those that touch on the environmental and societal impacts of a company’s operations, and the company’s governance of the same. ESG’s use as both an investment risk-assessment framework and a corporate risk-management strategy is not entirely new; elements have been woven throughout corporate ecosystems and value chains, to a degree, for some time. But the recent, more palpable attention to climate change coupled with the increased importance of stakeholder-capitalism amid social unrest have facilitated its re-emergence.

 

The more attention that is paid to performance on ESG metrics (greenhouse gas emissions, water consumption, employee diversity and other labor practices, executive compensation strategies, etc.), the more demand there has been for access to company data about them. Enter voluntary (and increasingly mandatory) disclosure regimes. ESG factors remain difficult to quantify and standardize, but nevertheless, over the past two decades, numerous organizations have devised voluntary reporting frameworks, which vary in content and structure. These include the Global Reporting Initiative, the Sustainability Accounting Standards Board (SASB), the International Sustainability Standards Board (ISSB) and the Task Force on Climate-Related Financial Disclosures (TCFD).

 

On the mandatory side of things, the federal government under the Biden administration has moved forward with several proposals. First, the Securities and Exchange Commission (SEC) proposed sweeping disclosure rules related to climate-related risks and greenhouse gas (GHG) emissions. The SEC then followed that up with a proposal to amend the "Names Rule," to place limits on the use of terminology such as "growth," "value" or "ESG" in investment names, and another to amend regulations to require that investment advisers disclose GHG emissions and other ESG-related information for certain funds. The SEC finalized the Names Rule amendments in Sept. 2023, and anticipates finalizing the remainder in 2023 as well.

 

The Federal Acquisition Regulatory Council (the entity that prescribes regulations for government contracting) also hopped onto the climate-disclosure bandwagon by proposing a rule that would require federal contractors categorized as "significant" ($7.5M in annual obligations) and "major" ($50M in annual obligations) to inventory and publicly disclose Scope 1 (direct) and Scope 2 (indirect) GHG emissions. Major federal contractors would also be required to disclose Scope 3 (value chain) emissions and set science-based targets to reduce emissions. This rule is also expected to be finalized in 2023.

 

In concept, in addition to providing more comparable, decision-useful information to investors, more robust disclosures may also help to flush out claims of "greenwashing," where an entity makes an unsubstantiated claim about environmental sustainability. And these days "greenwashing" is just the tip of the iceberg—allegations of "bluewashing" or "wokewashing" (claims about commitment to social justice), and "pinkwashing" (LGBTQ+-friendly claims) are also emerging as risks. Leveraging federal and state consumer protection standards, stakeholders are more empowered than ever to hold companies accountable for their claims.
 

The Anti-ESG Backlash
In the U.S., ESG has become an issue that is starkly divided among party lines. Generally speaking, the Democratic Party has been more supportive of policies that consider ESG principles, while the Republican Party has been proactive in its quest to forbid consideration of ESG factors in corporate and investment decision making. The anti-ESG constituency seems to view ESG as fundamentally anti-shareholder and anti-capitalist, since they see ESG factors as not directly tied to the pecuniary performance of a company.

 

Congress
Action in Congress has been more impactful rhetorically than legislatively—to be sure, Republican legislators have introduced several anti-ESG pieces of legislation in the House of Representatives to require companies only to disclose material information and to rein in the SEC’s regulatory reach, but they are all but assured of failure should they reach the Senate.

 

Proposed legislation, letters, subpoenas and hearings are the primary way members of Congress have expressed dissatisfaction with ESG. The criticism has taken many forms, but two are particularly notable:

 

First, since at least late 2022 ESG opponents have expressed the view that certain actions taken in service of greenhouse gas-reduction goals specifically might be anti-competitive and could violate antitrust laws. House Judiciary Committee Ranking Member Jim Jordan (R-OH) sent information request letters to that effect on December 6, 2022, to Ceres and Climate Action 100+, two organizations promoting investments in clean energy sources and away from fossil fuels. Antitrust concerns were reiterated throughout 2023, such as in July when the Judiciary Committee sent document requests to asset managers including BlackRock and Vanguard, seeking information aimed at identifying potential violations of U.S. antitrust laws via collusive agreements to "decarbonize" assets under management and to achieve net-zero emissions. (States, too, have expressed concern regarding antitrust implications of ESG, with 21 State attorneys general sending their own letter to asset managers expressing concern that they "have made commitments that cast doubt on their adherence to fiduciary requirements, representations to consumers about their services, and compliance with antitrust laws.")

 

Second, certain members of Congress have used their power to compel testimony from ESG detractors and advocates, which also provides a platform for those members to express their own opinions. The summer of 2023 was particularly active on this front, starting in May when the House Oversight and Accountability Committee brought several State attorneys general to participate in the first in a series of ESG-themed oversight hearings. The hearings continued in June, when that same Committee focused a hearing on the impact of ESG on markets and consumers. And in July, the Financial Services Committee held a hearing on the SEC’s proposed rule regarding climate disclosures.

 

States
An area where states have been more successful than Congress is legislation, with several anti-ESG legislative developments making headlines of late. The legislation has taken several forms, but a consistent through-line is a focus on restricting the use of ESG criteria or ratings in decisionmaking. A Kansas bill that became effective in July 2023 exemplifies several of these trends. Today in Kansas, state officials, including those involved in procurement, are prohibited from providing preferential or discriminatory treatment based on ESG criteria. Investment managers acting on behalf of the state are to act "solely in the financial interest of the participants and beneficiaries," meaning not with a purpose of advancing ideological beliefs. Additionally, no state agency may require any person or entity to adopt ESG criteria. Interestingly, this bill was not passed as originally proposed—lawmakers tempered it at least in part because Kansas Public Employee Retirement System officials expressed concern about how much money the system stood to lose. Other states, including Florida, Idaho and West Virginia have also enacted anti-ESG laws with similar provisions.

 

What’s Next
Whatever the merits or actual impacts of the anti-ESG backlash, it has undoubtedly tamped down some of the prior enthusiasm for ESG in some corners. In fact, a new trend has taken hold, deemed "greenhushing," where companies may be staying the course on their ESG goals, but without publicizing them.

 

But whereas the United States continues to debate the pros and cons of ESG, the European Union is moving forward. The EU has proceeded to finalize its Corporate Sustainability and Reporting Directive (CSRD), intended to give investors and stakeholders greater access to information concerning companies’ ESG-related impacts—and its application will reach at least some companies that are not based in the EU, whether or not the U.S. finalizes any of the currently-proposed regulations. CSRD will also likely impact some companies that, while not expressly in scope, find themselves in the value chain of regulated entities and therefore may have to adapt practices for and/or make additional disclosures to their customers. The divergence between the EU and the U.S. is understandably causing concern about inconsistent or conflicting requirements for companies with connections to both jurisdictions, directly or indirectly.

 

Conclusion
The ESG movement, and the blowback it has been receiving recently, will likely be part of the corporate conversation for the foreseeable future, for better or worse. Companies monitoring these developments closely and engaging in internal policy or external disclosure activities with a clear-eyed understanding of the risks and benefits at play will be better prepared to respond to these shifting pressures.