Creeping political interference into how pension funds run their money has been brought into stark relief by US Republicans’ anti-ESG backlash, but they’re far from alone.
Pension funds are confronted with immense pressures such as meeting their liabilities, managing deficits, navigating turbulent global economies, and coping with growing regulatory burdens. For public pension funds there is the added pressure from politicians.
It can be an uneasy relationship. In 2016, the head of Canada Pension Plan Investment Board, Canada’s biggest pension fund, warned it should operate “at an arm’s length” from the government after it called on the fund to invest in Canadian infrastructure. Similar concerns were raised last year in the UK when the government said it would ask local government pension funds (LGPSs) to set an ambition of investing 5% of their assets in projects which support their local areas.
This type of political interference hit a crescendo last year with a wave of US Republican states bringing in laws seeking to curb ESG investing. Florida Governor Ron DeSantis has been one of the most assertive in his lawmaking. Last August, he banned the state’s pension system from making investment decisions based on ESG factors and on Monday he proposed a sweeping range of related new laws.
These include prohibiting the state’s pension system and banks that hold public funds from using ESG factors, and requesting ESG information from suppliers in the procurement process. DeSantis is also proposing banning the state from giving ESG-related information to credit rating agencies when it issues bonds and barring investment firms that engage in ESG from lending to Florida’s state or local governments.
Similar actions – coming from at least 18 US states who have proposed or adopted anti-ESG legislation in the past year – are starting to have real consequences.
US ESG funds saw outflows of US$6.1 billion in Q422, compared to US$0.3 billion of inflows the previous quarter, according to investment bank Jeffries, which says the US anti-ESG backlash is a key driver of this.
‘Red state’ pension systems are starting to divest from financial firms considered to be “boycotting energy” in reaction to laws passed by the likes of Utah, West Virginia and Texas.
There’s been fightback to these moves from US Democrats. A coalition of state treasurers penned a letter opposing the anti-ESG movement and state attorneys general have defended fund managers’ use of ESG factors in investment risk management.
Stay out of capital markets
But Democrats have also been in the firing line for political interference into public pension plans.
California lawmakers want their public pension plan system – including major funds California State Teachers’ Retirement System (CalSTRS) and California Public Employees Retirement System (CalPERS) – to divest from fossil fuels. A bill failed last year, but has been tabled again.
CalPERS has warned that if it were to divest from fossil fuel companies and they performed well, employers and employees would bear the investment loss through increased contribution rates – the fortunes of oil majors this month will bolster this argument.
University of Oxford Professor Bob Eccles says this type of interference from Democrats is “as senseless” as the actions of Republicans: “Politicians also have no business deciding whether an issue is a material risk or not,” he says. “In a very polarised America I guess it’s nice in a bittersweet kind of way to find something the two ends of the political spectrum have in common. Both are trying to interfere with America’s capital markets.”
Bryan McGannon, Managing Director at NGO US SIF, says that while on the surface the actions are similar, the intentions differ. California’s proposed divestment laws addresses the systemic risk of climate change, he says. In contrast, the actions of red states have the intention of stopping ESG and protecting industries such as fossil fuels and mining, not to protect beneficiaries.
Dmitriy Ioselevich, founder of 17 Communications, which works with ESG and impact investors, says the proliferation of anti-ESG legislative proposals – influenced heavily by the American Legislative Exchange Council (ALEC) – has roots in powerful fossil fuel interests. He warns their “playbook” is to start at a state level – where NGO Influence Map has said there is greater scope to steer policy – as a testing ground for trying to influence at a federal level.
Proponents of these anti-ESG laws say their actions are designed to protect the investments of pension scheme savers. But McGannon says this contradicts market consensus on the materiality of ESG factors.
Players such as Larry Fink CEO BlackRock and more recently State Street CEO Ronald O’Hanley say ESG factors are important for investment risk management. McGannon adds that the most active opposition to anti-ESG bills has been state-level banking associations. “This is an unusual source of pushback in our minds, as they tend to be conservative. So, it’s interesting to see them telling red state legislators that this is bad policy.”
And in recent days Republican politicians and pension funds subject to anti-ESG movement have started to fight back too. The North Dakota House of Representatives have rejected a bill that would have created a list of financial institutions that boycott energy. The Kentucky Employees Retirement System has reportedly said it will not divest from firms such as BlackRock which feature on a mandatory boycott list created by the state government as it may breach its fiduciary duty.
Increased cost and burden from politicisation
Steven Rothstein, Managing Director of the Ceres Accelerator for Sustainable Capital Markets, operated by the Ceres investor network, tells ESG Investor there is growing research being done of the cost of anti-ESG legislation. He says University of Pennsylvania’s Wharton Business School has done research showing that in Texas, which has limited the amount of banks the state can work with over ESG factors, the issuing of a municipal bond would cost the taxpayer US$3-500 million more.
A second study by economic and policy consultant firm Econsult Solutions found the US boycott of ESG could cost taxpayers US$700 million across six states, he says.
UK public pension plans are also under risk of additional costs from government intervention, warns the country’s Pensions and Lifetimes Savings Association (PLSA). A new law was passed last year that prevents LGPSs making investment decisions that run counter to British foreign and defence policy. Conservative Robert Jenrick, the MP who tabled the law, believes public pension funds should not make ethical investment decisions, such as boycotting Israeli companies because of the country’s treatment of Palestinians.
Joe Dabrowski, Deputy Director – Policy at the PLSA, tells ESG Investor that such decisions risk additional costs to local government employers and employees – and to the many private sector operations in the scheme. It has opposed the law since last year.
“The LGPS has extensive governance rules to ensure investments are carried out in line with UK law and the fiduciary duty owed by scheme managers to the scheme members. In addition, the investment fund ‘pools’ in England and Wales are predominantly FCA regulated. We do not, therefore, believe it further legislative intervention in the operation of LGPS investments or changes to the long-standing law in this area are necessary,” he says.
He also notes that the law is ambiguous: “There are many areas of foreign policy where determining whether an investment presents an ‘ethical’ dilemma or is in line with UK government policy is less clear,” he says, noting that some nations did not approve the UN statement criticising the Russian invasion of Ukraine which was strongly championed by the UK government foreign policy. He questions whether the law would have an impact on pension scheme wanting to invest in these democracies.
Jacqueline Jackson, Head of Responsible Investment at London CIV, questions the reasoning behind the law, noting that genuine social risks can materialise into financial risk. “It could be argued that it is just semantics, because if an investment manager makes a financial-based decision, then that’s not sanctioning a company or boycotting a brand based on politics. It becomes moot very quickly.”
She says in cases where pension scheme members may want an ethical divestment from a brand or country, London CIV’s preference is to takes an engagement approach. This has been the case with companies operating in occupied Palestine and Xinjiang Uyghur Autonomous Region.
With human rights issues, members may be more likely to share differing perspectives than with risks relating to climate change, which are easier to quantify. “That’s why it’s financially advantageous for LGPS funds to take politics out of the equation and assess all risks from a fiduciary duty perspective,” she says.