From obscure academic topic to major campaign theme, ESG (environmental, social and governance) investing has catapulted itself onto the political stage. Forecasts suggest that assets in ESG funds are expected to grow from roughly $20 trillion in 2022 to a staggering $40 trillion by 2030.
Our new paper is Santa Clara Journal of International Law We consider whether the rise in ESG is due to market forces or government intervention, and conclude that government policies, rather than investor preferences, are primarily driving ESG.
Governments around the world have imposed numerous ESG-related regulations, with many more underway or under consideration. Indeed, governments have encouraged an ESG surge as forward-thinking investors seek to divest from sectors that will soon be punished, such as oil, natural gas and firearms.
Under a level playing field, ESG-weighted portfolios compete with market-tracking index funds, which offer better diversification and risk reduction. Government regulations requiring climate-related disclosures benefit ESG funds by reducing investor choice, making securities in ESG portfolios (more) attractive than under perfect competition.
Whether ESG is driven by market forces or government backing also influences interpretations of the emerging “anti-ESG” movement. Are some states restricting or banning state funds, including public pensions, from investing in ESG, restricting investor freedom or protecting investors from predation by other governments?
We document a range of government initiatives to drive ESG integration in financial markets. Governments are using the full range of policy tools at their disposal, including mandates, regulations, taxes and subsidies.
Government emissions reduction commitments under the Paris Climate Convention are driving the transition to renewable energy in the European Union, Australia and the U.S. The European Union and the U.S. offer a range of tax credits and grants for clean energy projects and energy efficiency improvements.
The Biden administration is providing subsidies for wind, solar, electric vehicles and charging stations, and imposing stricter emissions standards on new vehicles and power plants. President Biden's executive orders have implemented ESG measures by the Financial Stability Oversight Council, the Securities and Exchange Commission, and the Department of Labor.
Additionally, most states have renewable energy portfolio standards that require utilities to procure a majority of their electricity from renewable sources such as wind and solar, and some states have goals for 100% renewable energy generation.
Conversely, governments also impose disincentives, such as taxes and bans on petroleum, plastic packaging and fertiliser.
The European Union is leading the way on ESG with its Green New Deal, climate legislation, and new reporting standards mandating emissions reductions. The European Sustainability Reporting Standard mandates ESG disclosure and audits. Similar mandates to disclose climate data, diversity metrics, and sustainability practices are in place or proposed in the UK, France, Canada, and Australia.
Governments are increasingly mandating disclosure of ESG data such as carbon emissions and board diversity. Governments are mandating disclosure while private organizations such as the Climate Disclosure Standards Board are working to make ESG ratings a voluntary standard. More than 60 jurisdictions, including all members of the G20, mandate ESG disclosure, primarily through financial regulation or stock exchange listing rules.
Initiatives such as the Task Force on Climate-related Financial Disclosures, which is supported by major financial institutions and institutional investors, demonstrate a global effort to strengthen climate-related disclosures in the financial sector.
ESG requirements for companies listed on stock exchanges are becoming commonplace. Nasdaq and Dow Jones have both introduced board diversity rules and sustainability indexes. Although stock exchanges are technically private, they are heavily regulated and governments are driving these rules. European stock exchanges are imposing similar rules.
Financial markets were heavily regulated long before ESG came on the scene, so we investigated whether regulation merely gave regulatory permission to investors interested in socially responsible investing. The Department of Labor's permission for pension ESG investing is one of the few permissive measures, although it raises questions about fiduciary duty. Overwhelmingly, the regulation is similar to the SEC's climate reporting mandate.
Over the past year, large financial institutions have retreated on ESG, resulting in net outflows from ESG funds. This withdrawal suggests that institutions may have overestimated market demand for ESG. It also supports our assessment that governments have been driving ESG all along.
Allen Mendenhall
Allen Mendenhall is Associate Dean and Grady Rodger Professor in the Sorrell College of Business at Troy University.
He holds a BA in English from Furman University, an MA in English from West Virginia University, a J.D. from the West Virginia University School of Law, an LLM in International Law from Temple University Beasley School of Law, and a PhD in English from Auburn University.
Daniel Sutter
Dr. Sutter is the Charles G. Koch Professor of Economics at Troy University’s Manuel H. Johnson Center for Politics and Economics and holds a PhD from George Mason University.
His research interests include the social impacts of extreme weather and disasters, the economics of news media, the market for economists and economic research, environmental regulation, and constitutional economics.
Dr. Sutter has published over 100 articles and papers and authored/edited three books.
