The ESG movement threatens to impact taxpayers across the nation. How should SC respond?

What is ESG?

Across the country, powerful financial institutions are making investments and offering services based on environmental, social and governance (ESG) factors in place of traditional investment criteria, and it’s a trend that could have a major impact on South Carolina and local businesses. 

Environmental factors include things like a company’s stance on climate change or its energy usage, while social factors often mean support for left-leaning causes such as diversity, equity and inclusion. Governance primarily refers to corporate management structure, shareholder influence or executive compensation. Together, these factors make up a company’s ESG score, which can be used to deny it loans or other financial services if too low.

Ultimately, the ratings and criteria used are entirely subjective, whether determined by banks and credit rating agencies, or investment and accounting firms. There is no single-accepted national standard for ESG scores, as reported by The Nerve.

What are the issues surrounding ESG?

The growing ESG movement presents serious problems. Local businesses, for example, could be forced to comply with ESG policies of national banking and financial institutions just to get loans or qualify for low interest rates. It could also force businesses to do a lot more work. The Nerve reported last year how one South Carolina business said it might need to hire compliance officers just to deal with the litany of potential ESG mandates.

It’s also possible this top-down pressure could even affect the everyday citizen, who could, for example, be denied services by local banks because of their political views or social media posts. It is a system with serious implications for South Carolinians at all levels.  

But perhaps the most imminent concern is that of ESG-related proxy voting with state retirement funds, which typically involves investment managers exercising their shareholder voting rights to advance ESG policies. This is a legitimate risk, as two pro-ESG investment firms – New York-based BlackRock and Boston-based State Street Corporation – handle a substantial portion of the state pension plan, as The Nerve has revealed.

The need for legislation

Given the threats ESG poses to businesses, individuals and states, it is imperative that South Carolina consider legislation to minimize its negative impacts on taxpayers and on public dollars where possible.

At a minimum, South Carolina can and should take action to protect the state pension system from ESG interference, ensuring citizens’ hard-earned retirement dollars are invested solely based on financial factors meant to produce the best returns. This will require having stronger protections in place for proxy voting, so that ESG-minded investment managers aren’t free to advance their agenda using the public’s money.

The American Legislative Exchange Council (ALEC) supports legislation on this front, as does Americans for Tax Reform. ALEC’s model legislation emphasizes three main points:

1) Investment managers must act solely in the pecuniary interest of clients, which involves considering factors only associated with the financial risk and/or return of an investment.

2) Consideration of non-pecuniary factors is strictly prohibited. ESG factors may only be considered if they would have a material impact on risk and/or return.

3) Voting rights and pension assets must be protected. Retirement shares must be voted solely in the pecuniary interest of pensioners. 

The other issue that warrants legislative consideration is the impact of ESG on businesses and individuals. As a matter of principle, South Carolinians should not be deprived of financial services because of their political beliefs. At the same time, state government should be careful with how it addresses this issue, and not fall into the trap of banning only the social or political criteria it finds objectionable. There also is a concern about government overreach into what is fundamentally a voluntary transaction between two private parties (bank and individual). For these reasons, basic transparency requirements for state-based ESG practitioners might be the best approach, so citizens at least know what they’re dealing with.  

Ten states so far have enacted ESG-related legislation, according to a report from late last year. While South Carolina has yet to pass legislation, the state treasurer last October announced a plan to divest the remaining $200 million of BlackRock holdings from a $5 billion portfolio managed by his office, which is separate from the retirement system.

Proposed legislation in South Carolina

At least five ESG-related bills have been filed in the current legislative session.  

1) S.111 – Prevents banks and financial institutions from discriminating against customers based on subjective or arbitrary standards, which would include political affiliation, club memberships or other ESG-related criteria. However, they would be permitted to offer services based on subjective standards if those factors are disclosed to customers in advance. 

2) S.559 – Prevents banks and credit unions using social credit scores when deciding whether to offer loans. Banned social credit factors would include a person’s political views, religious beliefs, whether they own a firearm, and more. 

3) H.3564 – Requires companies that contract with state or local government agencies to certify that they don’t engage in economic boycotts or use ESG standards.

4) H.3565 – Requires the S.C. Retirement System Investment Commission (RSIC) and its retirement fund managers to invest funds solely to achieve a financial benefit for retirees and their beneficiaries, and prohibits investment managers from considering ESG factors.

5) H.3690 – Requires the RSIC to cast shareholder proxy votes based on pecuniary factors, which means those having a material effect on the financial risk or return of an investment, and excluding those promoting ESG objectives. The RSIC may only delegate shareholder proxy-voting rights to investment managers if they invest based on pecuniary factors, if the commission believes there would be a “superior” economic benefit in doing so, or if the commission wants to avoid a concentration of assets with one or more investment managers. Update: The House on 4/5/23 passed this bill 103-5.

These proposals are a commendable effort to reduce the impact of ESG on South Carolina. However, as we are passing the halfway point of the current legislative session, we encourage lawmakers to prioritize one or two bills for consideration, particularly bills like H.3565 and H.3690 dealing with the state pension system. This area most urgently needs attention when it comes to ESG and the threats posed to taxpayers. Of course, if additional reforms can be achieved in the near future, we will support those efforts.