15 Aug PUBLIC PENSION CORNER, #8
NEWS:
I. NZBA Disaster Continues
Last week, UBS announced its departure from the Net Zero Banking alliance. The largest Swiss bank’s announcement came on the heels of similar announcements from HSBC and Barclays, the largest and third largest banks in the UK, respectively:
UBS was a founding member of the NZBA in 2021. The financial institution said on Thursday it joined at a time when banks were working to cultivate decarbonization frameworks for financed emissions. Since then, the bank said it has developed and advanced its in-house capabilities in the area, but lauded NZBA for playing a “valuable role in helping banks establish initial target-setting frameworks.”
Earlier in March, UBS shared in its annual sustainability report that it had delayed its target to reach net-zero emissions across its own operations from 2025 to 2035. At the time, the bank attributed the delay to its “enlarged corporate real estate portfolio,” following an acquisition of Credit Suisse, and updated regulatory guidance.
The deferred decarbonization timeframe came a month after HSBC announced it was delaying its net-zero emission goal by 20 years, from 2030 to 2050.
II. State AGs Warn SBTi
This week, 23 state attorneys general sent a letter to the Science Based Targets initiative, asking for information from the climate organization and warning it about potential legal trouble it may face because of its advocacy. SBTi was recently singled out by Florida AG James Uthmeier for possible antitrust violations:
The AGs’ letter included a particular focus on the SBTi’s recently released Financial Institutions Net-Zero (FINZ) Standard, which it suggested formed an agreement to cut off funding and insurance to the oil and gas industry.
The letter follows the launch earlier this month of an investigation into the SBTi, alongside environmental disclosure platform CDP, by Florida Attorney General James Uthmeier into alleged potential antitrust violations and deceptive trade practices. Uthmeier is also a signatory to the new letter….
In July, the SBTi released its finalized Financial Institutions Net-Zero (FINZ) Standard, aimed at enabling banks and investors to set net zero-aligned targets for their lending, investing, insurance and capital markets activities. Among the key requirements set out for financial institutions to achieve goals aligned with the new standard is the publication of a “fossil fuel transparency policy,” requiring financial institutions to publish policies to immediately end project finance explicitly linked to fossil fuel expansion activities and general purpose finance of companies involved in coal expansion, end general purpose finance to oil and gas companies involved in expansion by 2030, and to transition portfolio energy activities to net zero by 2050.
COMMENTARY
By Stephen R. Soukup, President and Publisher, The Political Forum
“Chicago’s Impending Fiscal Disaster”
The other day, Civitas Institute published a piece by Thomas Savidge, a Research Fellow at the American Institute for Economic Research, detailing the budgetary problems facing both the city of Chicago and the state of Illinois. Although both polities have been grossly misgoverned for decades, especially in terms of their finances, the impetus for Savidge’s analysis was the enactment of Illinois law HB 3657 on August 1. That law, signed by the state’s politically ambitious Governor JB Pritzker, “increased benefits for first responders under Chicago’s Tier 2 pension system.” Indeed, the law added some $11 billion in unfunded liabilities to Chicago’s already woefully underfunded pension systems. Or to put it another way, Pritzker and the Illinois legislature took the smoldering fire that is Chicago’s fiscal condition – and especially its massively underfunded pension systems – and poured gasoline on them. The odds that Chicago will be forced to declare bankruptcy and that the equally profligate state of Illinois will be unable to do anything to help it have now increased dramatically.
Savidge suggests that a handful of culprits are to blame for the city’s dire fiscal condition, including the two most usual of usual suspects: overly feckless government spending and overly generous public pensions. He also blames the federal government in part, for what he, citing Legal Scholar Michael Greve, calls “cartel federalism,” and which Grever describes as “the displacement of institutional competition with the production and distribution of rents among politicians, bureaucrats, and concentrated industry sectors.”
I do not doubt for a second that Savidge is spot on here, and that Chicago and Illinois have both been irredeemably irresponsible in various ways over several decades, the results of which are these disastrous budget and pension deficits. I also don’t doubt the federal government has made all of this worse, largely because that’s what it tends to do.
At the same time, however, I would add that all of the other fiscal failures have likely been exacerbated – at least in the case of the pensions – by the politicization of the city’s and the state’s investments.
The state of Chicago’s public pensions in general is abysmal. Seven of the ten worst-funded municipal retirement systems in the country are Chicago pensions. Most of that underfunding is, of course, the result of factors unrelated to investment strategies and returns. Mostly, the underfunding is the result of interest on debt and ongoing actuarial adjustments. All of that said, the returns generated by the Chicago public pension systems are nothing to write home about. They are mixed at best.
To be fair, over the last several years, most of Chicago’s pensions have met their benchmarks. Of course, those benchmarks have been progressively lowered (see above), which has compounded the underfunding problem while also making returns appear more solid. Even so, the smoothing done in the cases of some of the pensions has left them underperforming their benchmarks, even in what should have been solid market years. For example, the Illinois Policy Institute recently noted the following about two Chicago highest-profile pensions:
Chicago’s fire and police pensions posted mixed results that reveal long-term vulnerability. The actuarial valuation spreads gains and losses over five years to better handle sharp fluctuations in market performance, and both funds underperformed. They expected a 6.75% rate of return, but Chicago police reported a smoothed return of 5.28% and Chicago fire returned only 4.8%.
Both funds are still carrying significant unrecognized investment losses from previous years that will be absorbed gradually. For the fire fund, that total is more than $52 million. For the police fund, it’s over $65 million.
More to the point, comparing returns to actuarial benchmarks measures only whether the pension investments are performing well enough to meet statistical payout models. It does not address whether pension investments are performing optimally, that is, whether they are doing as well as they can in comparison to other portfolios and strategies. To be blunt, Chicago’s pensions have dreadfully underperformed the broader markets for several years running.
(As I don’t need to tell you) Part of this is the result of the fact that public pensions are usually required by law to invest in a variety of instruments, far more diverse than the average stock market index – and far less volatile as well, including to the upside. That’s just how the game works.
That’s not the entire story, however, at least not in Illinois. In Illinois – as in other Blue jurisdictions, like California and New York City – public pensions are easily manipulated and, as a result, have been politically compromised. For example, in 2022, the Chicago Teachers’ Pension Fund voted to be fully divested of fossil fuels within five years (which, for the record, is now half over) and joined the Net Zero Asset Managers Alliance and Climate Action 100+. It and other Chicago pension systems have incorporated ESG into their investment processes, as has the Chicago Treasurer’s Office, which became the first major city treasury in the country to do so in 2018.
The following year, the Illinois legislature passed and Governor Pritzker signed the Sustainable Investment Act, which “strongly encourages public agencies and governmental units to develop a sustainable investment policy….” And while sustainability is considered important in the management of pensions in the state, it is worth noting that the “G” in ESG has been a primary focus of the state’s financial leaders for even longer.
In his great little book A Tyranny for the Good of Its Victims, Andy Puzder (currently the American Ambassador to the EU) argued that “The ‘G’ in ESG should be a ‘D’ because it stands for…Diversity.” He continued: “The ‘G’ in the ESG is social-policy engineering, not good corporate governance – in fact, it mandates bad corporate governance.” In a piece published just after the passage of the Sustainable Investment Act, Crane’s Chicago Business, confirmed that there is pension-management equivalent of Puzder’s “G = D” calculation:
For Illinois public pension funds, a primary focus has been diversity. Even before the adoption of the Illinois Sustainable Investing Act, the state’s pension code set an “aspirational” goal that 20% of investment fund advisers be minorities, women or people with disabilities.
[Angela ] Miller-May [chief investment officer of the Illinois Municipal Retirement Fund] says the fund has 25% of its $48 billion in assets managed by diverse firms. For majority-owned companies, “We like to see that there are diverse professionals in decision- making roles,” she says.
IMRF pushes majority-owned firms to steer business to minority and female brokers, lawyers and other suppliers. It looks for managers of large-cap funds to pay 30% of account commissions to minority or female broker-dealers. “In Illinois, we’ve focused on diversity and inclusion, but we’re looking to integrate more ESG factors into our investment process,” Miller-May says.
To be clear, none of this proves that Chicago’s (or Illinois’) pensions have underperformed because of ESG or sustainability or any other political act – but it does strongly suggest it. The preponderance of research shows that incorporating any factors other than traditional, pecuniarily material factors into investment strategies produces lower returns over time. This is especially true when those strategies mandate divestment from entire sectors.
Someday, in the not-too-distant future, the city of Chicago will likely come to Washington, hat in hand, begging for a bailout. That bailout should be rejected for any number of reasons, not the least of which is the unfairness and the moral hazard inherent in forcing all the taxpayers in the country pay for the politicization of public pensions by Chicago’s recklessly irresponsible public fiduciaries.
