14 Nov Send Lawyers, Guns, and Money
The following commentary/analysis is one I wrote in my capacity as a senior fellow at “the nation’s oldest consumer protection agency,” Consumers Research, where, among other things, I compile a weekly letter for public pension-fund managers. I am sharing it here today because I thought it might be useful to some of you.
The ESG Worm Turns
Although the history of ESG is long and complicated (as I detail in The Dictatorship of Woke Capital), the practice as we know it today dates roughly to 2005, and to the United Nations Principles of Responsible Investment (UNPRI). An important but often forgotten part of the effort to encourage participation in the PRI and in the new strategy of ESG was a study, commissioned by the United Nations Environmental Project (UNEP) and performed by Freshfields Bruckhaus Deringer, a London law firm with a nearly quarter-millennium pedigree. The question that UNEP wanted the law firm to answer was this: “Is the integration of environmental, social and governance issues into investment policy (including asset allocation, portfolio construction and stock-picking or bond-picking) voluntarily permitted, legally required or hampered by law and regulation; primarily as regards public and private pension funds, secondarily as regards insurance company reserves and mutual funds?”
Freshfields – which was, of course, hand-picked by the UN – concluded that the practice of incorporating ESG into investment policy was not only permitted but was nearly obligatory. Indeed, failure to integrate such variables into investment decisions, the firm insisted, was itself a bona fide failure of fiduciary responsibility. “Conventional investment analysis,” the firm wrote, “focuses on value, in the sense of financial performance. As we noted above, the links between ESG factors and financial performance are increasingly being recognised. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.”
Ever since, innumerable public and private entities around the (most Western) world have behaved as if the Freshfields declaration was gospel truth, an irrefutable pronouncement that ESG is, everywhere and always, a necessary and unassailable component of good investment stewardship.
The catch, of course, is that the “increasing recognition” Freshfields cited was inarguably tentative and was, at least in part, animated by wishful thinking. Over the last two decades, the validity of these “links between ESG factors and financial performance” have been challenged, tested, and, in nearly all cases, proven illusory. No one doubts that, in some, relatively rare instances, environmental and social considerations can and do have serious and important pecuniary implications for corporate performance (and, by extension, investment performance). For the most part, however, the link between ESG factors and “financial performance” is unprovable at best and often fully refuted. The best empirical evidence that exists shows several things: that ESG assumptions are nearly all unsupported, that the support they once enjoyed was based on poor research and faulty model construction, and that, as a result, UNEP’s Freshfields declaration fostered widespread false confidence in a mistaken interpretation of investment managers’ fiduciary responsibilities.
The repercussions of the first two of these conclusions have been evident in the markets – and especially in American markets – for much of the last three years. ESG funds have nearly universally underperformed their traditionally managed counterparts, and investors have, as a result, been aggressive in their retreat from ESG. Over that, countless ESG funds have closed or merged, while inflows to remaining funds have slowed to a trickle.
As for the third conclusion – that the Freshfields declaration prompted fiduciary failures on the part of countless investment professionals – the election results from last week may be the catalyst for the realization of those repercussions. Bloomberg’s Frances Schwartzkopff reports as follows:
ESG fund managers are being urged to keep their lawyers very close, after Donald Trump emerged as the winner of the US presidential race.
Trump’s return to the White House threatens to turbo-charge a years-long GOP assault on environmental, social and governance investing strategies. Investors intending to continue with ESG portfolios will need to ensure they understand the intricacies of the US legal system well, according to analysts at Jefferies Financial Group Inc.
“We’d encourage all ESG fund managers to have a lawyer on the team, or on speed-dial,” analysts led by Aniket Shah wrote in a note to clients on Wednesday. “Antitrust risk remains high for asset managers in ESG; there haven’t been any cases yet, thus there is no legal precedent. Further, legal risks regarding fiduciary duty will stay relevant as states enforce anti-ESG laws.”
It is entirely possible that the ESG community will come to regret the current SEC Chairman’s fixation on climate and climate-related promises made by investment managers. Although the Commission’s ESG task force has officially been disbanded, the infrastructure for investigating and, if necessary, prosecuting those who have made ESG-related promises they can’t keep remains intact.
Ironically, it’s not as if any of this should come as a surprise to any of the parties involved. ESG opponents in general have been warning for some time that a reliance on outdated and biased justifications for putting politics and theoretical stakeholders ahead of returns and shareholders would eventually result in legal ramifications. More specifically, Consumers Research has been explicitly warning various corporate entities that the lawfare has already begun and could easily be turned against anyone who has willingly enabled the practice. As was noted in the last edition of this newsletter:
Last week, Consumers Research sent a letter to five U.S. banks warning them that their unrealized (and unrealizable) ESG claims could put them in legal jeopardy. The consumer rights organization cautioned the banks that New York AG Letitia James’ action against JBS USA Food Company, which alleges misleading claims related to ESG and beef production, could set a precedent and make the banks similarly liable:
Food production and food availability on store shelves are critical issues for consumers. This places a greater emphasis on action taken by the New York Attorney General’s office which highlighted a major risk to companies directly involved in financing and supporting the national food supply chain.
Recently, JBS USA Food Company (JBS) was sued by New York Attorney General Letitia James over public ESG statements and sustainability documents. The lawsuit alleged JBS’s public statements and sustainability documents set unattainable goals regarding net-zero emissions—goals that could not be met so long as JBS continued to produce beef products—and that the JBS commitments misled consumers. …
Consumers’ Research is concerned that it is only a matter of time before the banks that finance food supply production companies, like Citibank, are subjected to state actions targeting their unrealistic net-zero commitments, as has happened with JBS.
Consumers Research has also warned ESG-involved retail businesses about their liability in the same matter and intends to continue to warn businesses about the legal and reputational risks their ESG-related efforts could engender.
To be blunt, with the change in administration in Washington, there is reason to believe that all of this is but the tip of the proverbial iceberg. At the very least, by the time the second Trump term ends, the assumptions underlying the UNPRI, the Freshfields declaration, and the ESG ethos more generally will have been amply tested.
