POINTS OF REFERENCE
ANTI-boycott legislation and texas’ ESG blacklist
by Emily Schmidt | October 6, 2022
Editor’s note: This article is part of a collaboration between APM Research Lab and the Ten Across initiative, housed at Arizona State University.
In August, Texas Comptroller Glenn Hegar released a “blacklist” of financial firms with plans to divest state pension funds from those companies based on the state’s 2021 anti-boycott law. This legislation, which now may be serving as a model for similar legislation in other states, prohibits state investment with firms that boycott energy companies.
To help understand the legislation and its effects, we have answered the following questions:
WHAT IS ESG?
ESG is a widely used acronym in the financial sphere for Environmental, Social and Governance. It is a framework that aids stakeholders (customers, suppliers, employees, investors, etc.) in assessing the sustainability, broadly speaking, of an organization or company.
More specifically, it considers an organization’s environmental impacts and risk management practices, relationships with stakeholders, and overall company leadership and accountability.
The term was first introduced in the 2005 “Who Cares Wins” initiative, which aimed to bring together international players from across the financial spectrum to study the role of ESG values in asset management and investment decision-making. Since then, ESG has become an increasingly popular method of analyzing how organizations make decisions.
Professor Tensie Whelan, director of the Center for Sustainable Business at NYU Stern School of Business, said ESG reporting is now standardized by numerous international initiatives, but there are different rating agencies that collect data from businesses and other sources to issue and weigh ratings based on their own internal analysis.
While companies may be internally motivated or externally pressured to report on their ESG-related activities, these initiatives are voluntary and companies may choose to report some, all or none of their data to external groups that rate ESG efforts.
WHAT TYPES OF ORGANIZATIONS ARE RELYING ON ESG STANDARDS TO GUIDE THEIR INVESTMENTS?
As of 2021, Divest-Invest reports the global fossil fuels divestment movement has reached $39.2 trillion across 1,485 public institutions, an enormous leap from $52 billion across 181 institutions in 2014.
A variety of organizations rely on ESG standards to guide their investing, primarily considering environmental metrics. Among them, faith-based organizations, educational institutions and philanthropic foundations are the largest groups that have made commitments to divest from fossil fuels.
WHAT IS ANTI-BOYCOTT LEGISLATION, AND HOW DOES IT RELATE TO ESG?
Generally, anti-boycott laws are established to prevent U.S. companies from adhering to aspects of boycott movements in other countries that the U.S. as a nation doesn’t support. This type of regulation was popularized when the American government passed legislation in the 1970s to prohibit U.S. businesses from being a part of the Arab League’s boycott of Israel in any way.
Within roughly the last year, as of Sept. 12, over a dozen states have passed or proposed anti-ESG bills, many using anti-boycott legislation as a model.
Texas was the first state to pass anti-ESG legislation using the anti-boycott format in 2021. It bars local authorities from doing business with banks that have adopted ESG policies and divested from Texas fossil fuel-based energy companies. In other words, Texas is boycotting banks that boycott oil or gas in any way.
Dr. Dan Garrett, assistant professor of finance at the Wharton School at the University of Pennsylvania, said that this legislation is essentially a form of discrimination. However, this definition of discrimination is “really hairy” because determining and assessing risks is approached differently by every state.
Under Texas’ new legislation, that means businesses who prioritize or support ESG.
Reasoning for supporting Texas’ approach to anti-ESG policy is captured succinctly in public testimony from the Texas Public Policy Foundation’s Dr. Brent Bennett: “We are now seeing major banks and investment firms colluding to deny financing to and investment in energy companies…However, one solution is to turn the tables on the banks. If they will not do business with us, we will not do business with them.”
HOW DID TEXAS ACT ON ITS ANTI-BOYCOTT LEGISLATION?
Although Texas’ anti-ESG bill took effect on Sept. 1, 2021, it wasn’t until this past August that Texas Comptroller Glenn Hegar, who functions as the state’s chief financial officer, compiled and published a list of 10 financial firms and 348 investment funds that governmental entities must eventually divest from.
The only American entity on the list was BlackRock, a multi-national investment firm. After the final list was announced, BlackRock released a statement saying it does not boycott fossil fuels, evidenced in $100 billion invested in Texas energy companies on behalf of their clients.
In March, Hegar’s office initially selected 19 firms that had potential to be on the final list. According to the Financial Times, the state used ESG ratings compiled by MCSI, an investment research firm, to screen for groups that have made official commitments to reduce their carbon footprint.
Although Hegar used the data to determine which firms cared about their environmental impact, a spokesperson from MCSI told APM Research Lab that the company’s ESG research was not to help Hegar’s office.
Rather, their “services are designed to enable institutional investors to integrate ESG considerations into their investment processes” and “customers determine how they will use our ESG ratings.”
These ratings can vary depending on the assumptions of those using them. For example, Bloomberg reported that almost 40% of the 348 funds Hegar identified invest in the oil and gas industry.
WHAT ARE THE BIGGEST IMPLICATIONS OF TEXAS’ ANTI-ESG BLACKLIST?
The biggest and most immediate quantitative risk of the legislation is to Texas’ state pension programs. According to the National Association of State Retirement Administrators, Texas’ pensions represented more than $357 billion in assets in 2021.
The funds that could be affected by blacklisted firms pulling investments include the Employee Retirement System of Texas, Teacher Retirement System of Texas, Texas Municipal Retirement System, Texas County and District Retirement System, Texas Emergency Services Retirement System and Permanent School Fund.
Even so, Garrett said trying to forecast the costs of bans like Texas’ is difficult.
“These states have the ability to pick these bans in a way that it looks like they're banning something, but they're not actually hurting themselves,” he said.
In the broader scope, there is also the question of whether Texas is the catalyst for anti-ESG bills and what that means for future legislation.
Garrett said there are other states that are “pretty blatantly copying” Texas, but the foundational language for this legislation was introduced in a 2015 Kansas bill that didn’t go anywhere.
In addition to more pressing financial questions, Whelan said that laws like this will set a precedent for devaluing sustainable business.
“Corporations need to pay attention to certain environmental, social and governance issues that have a significant impact on their financial performance,” she said.
“And investors need to incorporate understanding of how those companies are managing those issues into their investment decision-making, to support, for example, pension holders, who are in these products for the long-term, not the quarterly returns.”