States turn up the heat on ESG investing
A pumpjack (oil derrick) and oil refinery in Seminole, West Texas. dszc via Getty Images
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At issue is whether mandates about environmental, social and governance investment strategies infringe upon a state fiduciary’s duty to maximize returns.
This article is from a series about public finance issues that are likely to capture the attention of lawmakers this year. It was originally published by The Pew Charitable Trusts.
Environmental, social, and governance (ESG) investment strategies continue to gain popularity among investors and financial institutions, but with their rising prominence has come a growing divide in state attitudes about the ESG approach. ESG approaches consider the impacts that various investments have on people and the planet. They also can illuminate material risks and opportunities—such as a company’s record on employee relations or compliance with environmental regulations—that should be considered as part of any financial decision-making.
In recent years, four states—Colorado, Illinois, Maine, and Maryland—enacted legislation encouraging public pension funds to include ESG factors in investment decisions, while in 2023 alone, 14 states adopted laws discouraging ESG considerations or banning ties to financial companies that do so. Most of this state legislation has focused on public pension investments, although some bills have encompassed other aspects of government finance, including banking, contracts, and borrowing.
Moreover, several states that have proposed but not passed ESG-related legislation—such as Arizona and Missouri—have introduced bills again in 2024. And lawmakers in California are still considering legislation that would require the state’s pension systems to divest from fossil fuels by July 2031.
As more states pass legislation on social and environmental investing strategies, the national debate over the potential costs of both pro- and anti-ESG mandates is likely to heat up. At issue is whether ESG mandates infringe upon a state fiduciary’s duty to maximize returns, either through lost investment opportunities or by imposing a higher cost of doing business.
Further, some evidence suggests that policies governing ESG considerations may have unintended consequences for other areas of state and local government finance. For example, boycotts that cut business ties with banks that embrace ESG investing practices may limit governments’ underwriting options, leading to less competition and higher borrowing costs for states. In Texas, a top source of new municipal bond sales, five of the municipal banking industry’s largest underwriters left the state after legislators in 2021 prohibited state and local entities from contracting with banks that have divested from oil and gas companies. Research published the following year found that their exit resulted in more than $500 million in higher borrowing costs for local governments in the state over just eight months.
Some municipal bond market stakeholders are concerned that boycotts like the one in Texas could strain the relationship not only between banks and the individual states, but also between banks and government issuers more broadly. But others argue that states are right to reject investment strategies and financial service providers that potentially leave money on the table by avoiding fossil fuels. And especially in states where oil drives a large part of the economy, officials are concerned that ESG investing is harmful to state interests.
“I just want to have real conversations,” said Louisiana State Treasurer John Schroder, who in 2022 cut the state's ties with certain financial firms over ESG investing practices. “I'm responsible for investing money and getting a return. [That company was] basically trying to force policy down our throats.”
Two lawsuits are testing states’ various views on ESG investments. One case that is pending before the New York Supreme Court contends that pension asset managers breached their fiduciary duties when they decided to stop investing in fossil fuels. Experts say that the suit, brought by four New York City employees and a national nonprofit organization, could provide a basis for further court challenges to ESG investing.
But in Oklahoma, a former state employee is making the opposite point. With the backing of labor and other pro-pension organizations, former Oklahoma Public Employees Association President Don Keenan is suing the state over its boycott of firms that divested in fossil fuels, arguing that the mandate imposes unnecessary costs on the pension system. The Oklahoma Public Employees Retirement System has used a legal exemption to so far avoid divesting from the blacklisted companies, arguing that it would cost the state’s pensioners $10 million.
Liz Farmer, former author of the Public Finance Update newsletter, works on The Pew Charitable Trusts’ state fiscal policy project.
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