Republican complaints about “ESG investing” have been building in recent years. But they have not always been clear about what they want to do about it besides complain.
The whole concept of ESG investing — which puts great weight on environmental, social and corporate-governance considerations when allocating capital — can be amorphous. And for good reasons and bad, Republicans are reluctant to have the government interfere in the workings of capital markets.
They still don’t have a complete answer, which is probably just as well. But come January, when they will control the House, they will be able to do more than complain. I spoke last week to Representative Andy Barr of Kentucky, one of the top Republicans on the House Financial Services Committee.
Barr rejects the notion that ESG investing is simply the market at work. “It’s a distortion of the natural flow of capital,” he says. “What it is doing is steering investors, in many cases unwittingly, to higher-fee, low-return and less diversified investments.” He cites a recent study that found that only 24% of investors could correctly define ESG investing and only 21% knew what ESG stood for, adding: “Anecdotally, I find this myself when I talk to broker-dealers and investors in central Kentucky.”
He does make one concession to ESG: “Investors have the private-property right to allocate their capital however they want, and if they want to invest in a way that sacrifices return for some political reason, that’s their decision.” But only if that is their decision: Barr detects “a principal-agent problem when asset managers decide on their own to sacrifice owners’ returns for non-pecuniary reasons like ESG.”
Barr is similarly skeptical of claims that there is no trade-off between ESG goals and returns: Global ESG funds have underperformed the market by 250 basis points per year, he notes. The Securities and Exchange Commission has proposed requiring companies to disclose their “climate risks,” which he considers a way of steering investors toward ESG investments. Instead, he would like to see a requirement for investment advisers or managers “to disclose to the investor, the owner of the capital, that this fund is not designed to maximize returns. It will sacrifice returns to protect the planet or promote animal welfare or whatever. There needs to be informed consent that the investor is OK with earning lower returns in favor of those social or political goals.”
Barr is working on a bill, the ESG Act, that would make investment advisers and pension plans put their beneficiaries’ pecuniary interests first unless they say otherwise. Current law says that investments have to be made solely for the beneficiaries’ interests, but does not specify it’s for their financial interests.
Other Republicans have a different idea for combating ESG. They want to push proxy voting down from asset managers to their beneficiaries. Barr likes the idea in principle, but notes that the large number of investors in some funds makes it a challenge to implement.
Instead he prefers an idea from Representative Bryan Steil of Wisconsin. Steil, like Barr, thinks Glass Lewis and ISS are an effective duopoly in proxy advising. They “are frankly in bed with the big three asset managers,” Barr adds. Under his colleague’s proposal, there would be “a larger range of proxy advisers that retail investors can choose from. If you’re retiring and rolling over your 401(k) with Edward Jones, they would give you 12 different proxy advisers and you can read about their philosophies. One or two may have an ESG philosophy, but others will give you nonpolitical advice.”
Barr is well aware that with the Democrats controlling the Senate and the White House, Republicans can more easily investigate than legislate. So expect a series of hearings related to ESG.
“First we are going to focus on FTX as Exhibit A of the fraud of ESG,” says Barr. “Ratings for ESG are one of the things we’re going to be looking at. TruValue Labs gave FTX a higher grade on leadership and governance than Exxon Mobil. That’s even though FTX had only three board members.”
Oversight of the SEC will also be intensive, and will proceed in tandem with litigation. Last summer, in West Virginia v. EPA, the Supreme Court reduced the amount of deference it shows agencies when they interpret the laws that grant them power. That’s bad news for regulatory adventurism at the SEC, Barr believes.
He also expects hearings “where asset managers themselves will be asked to explain the extent to which their ESG strategies are in conflict with the interests of the actual owners of the capital.” Judging from our conversation, the asset managers might be looking forward to those hearings a bit less eagerly than the congressman is.
Ramesh Ponnuru is a Bloomberg Opinion columnist. He is the editor of National Review and a fellow at the American Enterprise Institute.
