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What does ESG mean for Kansas?

At the World Economic Forum in Davos this month, Bank of America CEO Brian Moynihan said that ESG standards were necessary to “align capitalism with what society wants from it.” But this vision of social change is not as efficient as its proponents claim and pose threats to transparency and government overreach from DC to Topeka.

ESG stands for environmental, social, and governance. The term was first used in 2006 in a United Nations’ Principles for Responsible Investment report, and over the past decade and a half, has become an umbrella term to denote “socially responsible” long-term investing. McKinsey defines their ESG efforts as follows:

  • Environmental – Mainly around energy sources and their consequences, like carbon emissions or contributions to climate change, as well as factors like pollution
  • Social – The relationship that the company has with its community, including “labor relations and diversity and inclusion.”
  • Governance – The company’s internal decision-making and culture: what values it supports, how it responds to stakeholder interest, and its legal compliance.

One of the core values of a free-market economy is that businesses can choose how they operate and invest. If a person of their company wanted to invest heavily in green energy or certain social causes, that’s all in their right to do.

The problems with ESG start to mount when government becomes involved and enforces a regulatory apparatus on private individuals. This is also when political motives and overreach comes in too. Though no federal law exists as yet, in March 2022, the federal Securities and Exchange Commission proposed ESG disclosure requirements that would have required businesses to add “climate-related disclosures” to their periodic reports. The disclosure would also include social aspects, such as compliance with the Uyghur Forced Labor Prevention Act which targets Chinese products made using forced labor of persecuted Muslims. Trying to reduce the pollution of companies or reliance on poor human rights conditions in other countries is a noble cause, but it all comes back to implementation. When ESG operates like a checklist whose bulletpoints aren’t being crafted transparently, it creates efficiency issues.

The flaws of ESG are rooted in the rating system of firms like MSCI, which assigned ranks varying from AAA for the most satisfactory firms to CCC for the worst. The ratings, which scholars argue are either based on stakeholder welfare ranging from workers to communities or societal and environmental impact, are highly subjective and prone to favoritism or holes in their logic. This is unfair when a legal product is subject to new standards and conditions by the bureaucracy instead of the law or courts. For instance, Phillip Morris is part of the Dow Jones Sustainability Index with other companies positively ranked for ESG…despite the fact that the tobacco goods they produce are the subject of “Merchant of Death” satire on the big screen that ESG proponents revel in. Similarly, Exxon and BP – two oil companies that activists argue are the face of global warming and thus should receive a low rating – are both ranked BBB. That’s the middle of the pack in terms of ESG-investing firms.

Another ESG concern is whether its tenet cause investment in funds less profitable than without restriction. A 2009 paper found that “sin stocks” of alcohol, tobacco, and gambling companies had a higher expected return than comparable stocks, in part because norm-constrained investors weren’t buying. According to the Harvard Business Review, companies with ESG portfolios had worse compliance records for labor and environmental rules, and charged fees 40% higher than traditional funds.

How does ESG affect Kansas?

Attorney General Kris Kobach joined a coalition protesting the usage of ESG by the International Shareholder Services and Glass Lewis Co for their clients like Kansas – including pension funds. BlackRock holds $4.5 billion of KPERS’ pension holdings, but has recently caused debate due to their pro-ESG platforms that caused Florida to pull $2 billion of assets in December 2022. State Treasurer Steven Johnson is working on legislation that would make the sole focus on state investment funds the financial return and not ESG-based factors.