KPERS has asked the state legislature to change the language used in its anti-ESG bill, providing tangible financial reasons to do so. This may set an example for other states to follow and even turn the tide against the Republican-led crusade against ESG.
- The Kansas Public Employees Retirement System (KPERS) has asked the state not to pass its anti-ESG bill due to cost impacts.
- Forced divestitures resulting from the bill would cost KPERs $1.14 billion, while also reducing total returns over the next decade by about $3.6 billion.
- Kansas joins four other Republican-led states in opposing anti-ESG proposals, which means that the tide may be turning in favour of sustainability reporting in the US, and the SEC’s proposed disclosure rule may be implemented in 2023.
The term ESG has been labelled as a ‘fascist strategy’ by the Republican establishment, that is being used by the ‘woke left’ against free markets and the fossil fuel industry. They claim that a pro-ESG stance does not serve investors as it prioritises environmental, social and governance issues over earning a financial return, and imposes diversity, inclusion and equity standards on firms that do not want it.
Yet viewing investments through an ESG lens provides investors with information they need to allocate capital most efficiently, in line with their own risk appetite and for the highest, most stable return on investment – a bedrock of the capitalist approach.
Multiple studies have shown an increasingly positive correlation between financial performance and sustainability, but now one State pension fund has put numbers to the cost of taking an anti-ESG approach – both immediately and in the longer term.
The Republican-led war against ESG in the US
Republican rancour against ESG began even before the defeat of the Biden administration’s climate action plan in July 2022, and has continued ever since. Perhaps dissatisfied by the passage of the Inflation Reduction Act (IRA) shortly thereafter, Republican leaders began to target the investment community in their bid to slow the adoption of ESG factors in investment decision making.
Quite obviously the sector with the most to lose was the fossil fuel industry, and it is no surprise that they backed the Republican anti-ESG agenda, even though the IRA contained several compromises for the fossil fuel industry.
Republican senators from 19 states wrote a letter to the chairman of the US Securities and Exchange Commission (SEC) in April 2022, opposing its new climate-related disclosures rule, which has been followed-up by West Virginia banning five major financial institutions from considering ESG factors in their investment decision making, due to their plan to limit involvement with the fossil fuel industry.
Through the second half of 2022, the Republican-led assault on ESG continued, with attorney generals of 19 US (Republican) states accusing Blackrock (NYQ:BLK) of a dereliction of duties to its investors in considering ESG factors, which was followed up shortly thereafter by Florida banning its state pension funds from considering ESG concerns in its investment decision-making.
Florida has gone as far as to introduce legislation in the state in February 2023 to “protect Floridians from the woke environmental, social, and corporate governance (ESG) movement that continues to proliferate throughout the financial sector.”
Going beyond investment management services companies and banks, Republicans have also targeted proxy voting firms ISS and Glass Lewis, claiming that a pro-ESG stance does not serve investors as it prioritises environmental, social and governance issues over earning a financial return.
Not content with limiting their campaign to a few states, the Republicans have now taken to the national stage. November 2022 saw the Biden administration propose the Federal Supplier Risks and Resilience Rule which would require suppliers to disclose emissions and climate risk-related data, as well as to ask them to set science-based emissions reduction targets – in line with increasingly global norms.
A group of US Attorney Generals are now arguing that the US government has overstepped the authority of the Federal Acquisition Regulatory Council (FARC). They said that it will add billions of dollars in costs over the coming decade, with a disproportionate impact on fossil fuel-producing states.
Also in November 2022, the US Department of Labour (DoL) issued a rule that allowed investment managers to consider ESG risks in their decision making, only for the Republicans to threaten legal action against the DoL, claiming that the new rule “prioritises woke Environmental, Social, and Governance (ESG) investing over protecting the retirement savings of approximately two-thirds of the US population, which is around 152 million workers”.
There are signs, however, that the tide may be turning against the anti-ESG campaign, as the new Arizona Attorney General Kris Mayes, a Democrat replacing a Republican, plans to halt Arizona’s anti-ESG actions, reasoning that that it is not the state’s role to tell investors or corporations how to invest their money.
KPERS’ action to change the language in Kansas’ proposed anti-ESG legislation is a further step in that direction, which may suggest that even with Republican-led states there is a recognition that considering sustainability in investment decision making is prudent.
What does the Kansas anti-ESG bill propose?
In a memo to Kansas House Financial Institutions and Pensions Committee, Alan D. Conroy, executive director of KPERs asked that the House Bill (HB) 2436 not be passed in its present form, on behalf of the KPERS board of trustees.
As introduced in the state legislature, “House Bill 2436 prohibits the State, any state agency, subdivision or instrumentality of the State from giving preferential treatment or discriminating against bidders or contractors based on environmental, social and governance (ESG) criteria, which are defined in the bill”.
The bill has also included the definition of “fiduciary commitment” to include the integration or consideration of ESG factors by a fiduciary, such as KPERS, in making investment decisions on managing assets. It goes further to restrict a fiduciary from delegating its proxy voting rights unless it states in writing that it has only considered financial objectives in doing so.
Proxy voting is the primary form of engagement between investors and shareholders, which allows shareholders to express their opinions on corporate strategy and performance. By limiting the delegation of proxy voting on the basis of financial factors only, HB 2436 is limiting shareholder engagement on ESG matters.
How did KPERs arrive at their assessment?
KPERs has based its request to change HB2436 based on the use and meaning of the word “fiduciary” in the bill, arguing that this would result in losses and costs to the state pension systems. KPERs claims that it would have to replace all of its current investment managers based on the definition of fiduciary, which “does not allow for any advertisements, statements, explanations, reports, or participation in coalitions, initiatives, or joint statements on ESG”.
The disqualification of a fiduciary would force the KPERs board of trustees to terminate their contracts as asset managers, and liquidate their investments with those managers. They would then be required to reappoint new managers based on the stipulations of the bill, and restructure employee retirement portfolios based on the available investment options.
According to KPERS, the premature sale of assets, which may not be immediately liquid or realise their full value, could potentially result in losses of up to $1.14 billion, and reduce the portfolio’s return on investment by 0.85%.
It also estimates that the portfolio’s earnings could be $3.6 billion lower than the existing one, over the next decade, based on the requirement to restructure investments to contain 60% listed equities, and 40% fixed income investments, or bonds.
This combination of losses could lower KPERS’ funded ratio by 10% to 60%, a level not seen since 2013, implying a loss of a decade’s worth of improvement achieved by the state’s employee retirement system. The funded ratio is a measure of a pension fund’s financial health, providing information on whether it has the ability to pay member benefits.
The past decade included extraordinary focus by the Legislature on improving the funded status of the System, including a new plan design (KPERS 3 cash balance plan), two pension funding bond issues, and several extraordinary contributions to the Trust Fund totalling more than $1.5 billion.
Where does this leave the anti-ESG campaign in the US?
As has been widely reported, pension managers and other market participants in several Republican-led states including Kansas, Kentucky, Indiana, Mississippi and North Dakota are pushing back against proposals that would prohibit state governments or pension funds from doing business with large financial institutions that have adopted environmental, social and governance (ESG) goals and policies.
While the battle over ESG is likely to continue, so is the growing focus on its necessary role in effective financial risk management. What ESG implementation has told the markets so far is that they do not have sufficient, accurate data to make risk-informed decisions – and that is something that no financial investor is going to be willing to ignore in the long run.
KPERS has provided a very tangible, numbers based argument against disallowing ESG factors to be included in investment decision making. While the reasons provided to dilute the language in HB2436 have less to do with the potential loss from not considering physical and transition climate risks to businesses and investments, it has at least given both legislators and investors pause for thought in their anti-ESG campaign.