A Short Guide to ESG: Legislation

Tracking and describing all ESG-related legislation falls well beyond the scope of this column (and this series) but surveying the legislative landscape will help us understand where things stand at the close of 2023. We’ll tackle ESG legislation in two parts: the US and the rest of the world (especially Europe).

Overall, the ESG agenda, especially the Environmental piece, has made significant advances around the world. In Europe, the laws are most extensive, and resistance seems pretty limited. In the US, the federal government has been mobilized to advance ESG priorities, while a handful of states have actively pushed back with their own anti-ESG legislation. 

US Legislation

The Biden administration went all-in on the ESG agenda. It’s hard to believe that during his presidential campaign, Biden positioned himself as a moderate candidate. On the first day of his administration, President Biden signed Executive Order 13985 “Advancing Racial Equity and Support for Underserved Communities Through the Federal Government.” A few months later, he signed Executive Order 14305 on “Diversity, Equity, Inclusion, and Accessibility in the Federal Workforce.” These executive orders mobilize federal agencies, and federal contractors, to prioritize Diversity, Equity, and Inclusion (DEI) in their hiring and personnel policies. 

This shows up in the documents of every federal agency. It lay behind the controversial mortgage fee extracted from some borrowers to subsidize other borrowers.  Diversity, Equity, and Inclusion ideas have been used to justify student loan forgiveness and a host of other bureaucratic agendas. ESG priorities made their way into massive spending bills, from the $1.9 trillion American Rescue Plan, to the $1.2 trillion Infrastructure Bill, to the $900 billion Inflation Reduction Act – which was primarily a massive green-energy transition bill. 

The Securities and Exchange Commission has made headlines over the past two years as it attempts to incorporate ESG goals into its regulatory rules; Everything from proposed disclosures regarding human capital management to proposed emissions-reporting requirements to modifying the Names Rule to go after investment funds that it claims have been engaged in greenwashing. It also launched the Climate and ESG Task Force under its enforcement arm a couple of years ago.

ESG Legislation in the states varies dramatically. On one end of the spectrum, California has enacted sweeping ESG priorities from carbon credit trading, to extensive emissions reporting, to requiring solar panels on new houses, to banning the sale of vehicles with internal-combustion engines. New York has passed extensive renewable energy requirements. State legislatures in Washington and Oregon have passed explicit statewide DEI policies. 

At the other extreme, states like Florida and Texas have enacted anti-ESG legislation. The Texas legislature passed laws prohibiting insurance companies from using ESG considerations and prohibiting municipal and state government entities from doing business with financial firms that boycott the oil and gas industry.

In Florida, the legislature passed reforms of school curricula, especially regarding Critical Race Theory. The policymakers have also begun exercising more oversight of special districts like Reedy Creek and state institutions of higher education like New College.

Many states fall in the middle of the spectrum. In red states, anti-ESG legislation has often not passed or has been watered down. Often, strong lobby groups oppose attempts to rein in ESG activity. But there are also practical difficulties in defining specific ESG behavior and squaring prohibitions with respect for private property, limited government, and individual choice. Sometimes the proposed legislation contradicts other important state interests or fiduciary responsibilities. For example, boycotting major financial firms because of their friendliness to ESG causes the cost of borrowing to rise or increases pension fund investment fees.

Global Legislation

As I have written before, the United Nations was both the originator of the term Environmental, Social, Governance, and its strongest proponent. Its Strategic Development Goals filter through the entire movement. Consider for a moment the growing impact of the UN global climate summits. The Paris Accords in 2015 set the world on a course toward “net zero.” This year’s summit concluded with the first explicit calls to phase out fossil fuels.

Just Energy Transition Partnerships and a new global Loss and Damage Fund are examples of inter-country loans and transfers to fund green-energy projects. But these programs are dwarfed by the redirection of trillions of dollars in private markets towards ESG Finance projects. While UN programs, resolutions, and deals are not binding, strictly speaking, they can create enormous pressure on government officials to enact policies consistent with or complementary to them. And they also create focal points and terms – such as “net zero,” ‘1.5^O,” “carbon capture,” etc. – that individuals, organizations, and governments use to justify ESG policies.

Europe leads the way on ESG. ESG policies there are both more pervasive and have been in effect for much longer than elsewhere. In Europe, companies have legal “stakeholder” responsibilities that give management wide leeway to orient policy and direct resources to any groups they choose. Many policymakers in the European Union want Europe to be the first continent to reach net zero.

The European Union passed the Green Deal in 2020, the European Climate Law in 2021, and created the Sustainable Finance Disclosures Regulation and the Taxonomy Regulation. In Germany, the sweeping Due Diligence in Supply Chains Act went into effect this year.  

These rules range from what kinds of vehicles Europeans can drive to mandating that all investors must report “sustainability” analysis on their investments broken down by vague ESG criteria. Companies in Germany with more than 3,000 employees, and eventually all companies with more than 1,000 employees, are responsible for the “wellbeing” of people anywhere in their supply chain – no matter how tangentially connected to their main business activity.

The Europeans have created an ESG ecosystem, involving tens of thousands of people and hundreds of billions of dollars, that, remarkably, does not add a single thing to ordinary citizens’ standard of living. No one participating in this ecosystem creates a single good or service for consumers. In fact, most of what they do makes it more expensive and difficult for companies to create and provide goods and services in the first place.

We might call the United Kingdom the “red state” of Europe, post-Brexit. The UK has scaled back some of its ESG targets – though it could hardly be characterized as anti-ESG. Instead, UK lawmakers seem slightly more cautious in the face of significant economic costs created by ESG requirements. No doubt pressure they face from British voters – something EU commissioners and UN officials don’t have to face – has led to these modest pullbacks.

I’ll make use of a personal family motto to describe ESG developments in 2023: “It could have been a lot worse.” Many of the more sweeping, costly, and destructive ESG proposals have at least been put on hold in the US. Proponents of ESG would like to see more legal requirements for companies to reach net zero, to hire more diverse boards and employees, and to cater to a variety of stakeholder interest groups rather than the interest of shareholders. 

The courts in the US will play an important role in the coming years in determining whether government agencies or politicians can continue pushing ESG priorities that fly in the face of longstanding legal norms around fiduciary responsibility, and constitutional rules about non-discrimination.

It remains to be seen how effective “anti-ESG” laws will be in slowing the ESG movement. That strategy may have limited scope and high costs. The more encouraging shift we have seen in 2022 and 2023 is greater scrutiny, slowing investment in ESG, and more financial leaders, like Larry Fink, distancing themselves from the term. 

What we need is not so much an “anti-ESG” legislative approach, but a deeply free-market approach. Rolling back renewable energy subsidies, “dear colleague” letters, regulatory overreach, as well as further strengthening fiduciary obligations will be enough to stop the wasteful, inefficient, and destructive elements of ESG without restricting liberty or imposing unnecessary costs on residents in red states.