Ron DeSantis, Florida’s Republican governor and likely future presidential candidate, has opened a new front in his party’s war against “woke capitalism.” He suggests to change the rules around how Florida government agencies borrow from the markets by issuing bonds.
The proposal is that they would no longer be able to collaborate with rating agencies that rate the bonds based on the ESG (environmental, social and governance) sustainability criteria that have become commonplace in the financial world in recent years. Government agencies and companies with lower ESG scores may see this reflected in their financing costs, and some politicians on the right object to this ‘interference’ in market valuations.
DeSantis has already committed in December to withdraw $2 billion (£1.7 billion) of state investments from BlackRock, the world’s largest asset manager and a major player in the ESG movement. This was after 19 Republican attorneys general told the asset manager in a letter: “Our states will not stand idly by for our retirees’ pensions to be sacrificed for BlackRock’s climate agenda.”
Eighteen states also have has proposed or passed legislation in the past two years that would restrict state dealings with financial institutions that use ESG criteria to restrict financing to sectors such as fossil fuels.
According to Republican Senator Kevin Cramer of North Dakota, banks and asset managers “must ignore the calls for ESG and shake up capitalism and stick to what they do best.” Former Vice President Mike Pence wants the next Republican Congress to commit to “ending the use of ESG principles nationwide.”
What they are doing wrong
The Republicans, newly in charge of a branch of Congress, are taking their quest to Washington, DC. Andy Barr, the new chairman of the House of Representatives subcommittee on financial services responsible for financial institutions, claimed that of America The financial system had been “co-opted by the intolerant left that is intolerant of diversity.” For the U.S. to be economically competitive, he said “our financial system must provide equal access to capital to all types of businesses.”
This either showed a remarkable ignorance of financial markets and the financial risks associated with environmental and social challenges – or he was cynically misleading to score political points.
The idea of equal access to capital goes against one of the central tenets of capitalism. The ability of different organizations to borrow and the price they pay are never the same. It depends on the risk of the investment and how many investors will take that risk.
Think of mining. It has an inherent impact on the environment and surrounding communities. Communities can tie owners up in lawsuits or even block access to mining if their concerns are not addressed. This can affect the mine’s profitability.
Researchers have shown how two gold mines with the same amounts of gold and the same extraction costs can be valued radically differently depending on local support. ESG ratings attempt to reflect such factors so that investors can make more informed decisions.
For asset managers like BlackRock, it is also about customer demand. If investments that mitigate ESG risks offer better risk-adjusted returns and investors increasingly avoid certain companies – be they weapons manufacturers or fossil fuel producers – this will influence where money flows.
BlackRock CEO Larry Fink recently said that his company lost about $4 billion in assets in 2022 from Republican-led states that took money, but added a total of $400 billion. Nothing nefarious or political here, just capitalism at work.
Owners of dirty assets can still raise capital. It’s just that the price could be higher. Look at the divergent coal strategies of mining giants Rio Tinto, Anglo American and Glencore.
Rio Tinto coal completely abandoned in 2018. Anglo-American did that created a separate entity for this asset called Thungela, while Glencore still has that coal in its portfolio and proposes to phase it out in a responsible manner over time. (Full disclosure: I hold the Rio Tinto Chair in Stakeholder Engagement at IMD, but the company has no influence over my research.)
Investors can choose between these strategies. At any given time, these companies’ financing costs will reflect the consensus assessment of the underlying risk, including ESG factors.
Glencore is not closed off from the capital markets and is doing quite well according to reports record profits for 2022 largely powered by coal. Still, the share price has not outperformed its peers, reflecting investor concerns about its long-term strategy.
Mining Stock Prices 2018-23
Is Capitalism Awakening?
David Remnick, editor of The New Yorker magazine, recently said that for “conservatives, wokeness is now the cause of everything negative.” He interviewed linguist Tony Thorne, who traced the term to a 1971 black liberation play in which the main character says, “I gotta stay awake.”
Thorne explained that for today’s progressives, especially after Black Lives Matter, “woke” became synonymous with “socially conscious” or “empathetic.” But conservatives, he said, turned this vague term into a proxy for left-wing self-righteousness, and so “anti-woke” became the rallying cry for every social change they opposed — just like “political correctness” a generation ago.
While American conservatives are primarily fixated on anti-wokeness – “Florida is where the woke are going to die,” Governor DeSantis said in his November letter. victory speech – it’s not just an American phenomenon. Thomas Chatterton Williams of Atlantic magazine, for example recently observed: “The French are panicking about it Wokism.” The European debate has not yet reached the financial markets, although this may only be a matter of time.
By calling ESG “woke,” conservatives imply that large parts of the $100 trillion global asset management industry have been hijacked by leftists. Having spent time with many asset managers, that’s nonsense.
Of course, not all is well in ESG land. Greenwashing is widespreadAnd rating agencies and asset managers are criticized for not sufficiently scrutinizing companies’ actual ESG performance.
Most dramatically in May 2022, German prosecutors raided the offices of DWSthe asset management arm of Deutsche Bank, following accusations that it had vastly overestimated its ESG investments. Lawsuits are underwayand DWS denies that it misled investors.
Yet the idea that a company would dress up “normal” assets as ESG simply demonstrates investor demand for these products. Similarly, greenwashing is pilloried because it makes it more difficult for investors to assess the underlying risks to a company’s future profitability. These issues highlight the need for better standards and regulations, which is to be expected in an emerging field like this.
Despite conservative opposition, analysts expect ESG investments will nearly double over the next three years to nearly $34 trillion, representing one in five dollars invested globally. This is not a deviation from free market principles, but a reflection of them. The fact that American Republicans are surprised by this says more about them and the echo chambers they have found themselves in than about the state of ESG.