Does ESG investing count as free speech?

Welcome back. Arguments are received for what sustainable finance means. . . creative.

For today’s newsletter, I looked at a lawsuit filed in Texas by a business group representing sustainable investment funds that claims the state’s refusal to work with financial firms deemed hostile to ESG violates free speech rights of those funds.

In addition, the debate over whether stock in military contractors should be considered an ESG investment.

Thanks for reading.

reaction to esg

Business group sues Texas officials over anti-ESG law

When James Madison sat down to draft the US Bill of Rights in 1789, the staunch civil libertarian could not have imagined that investors would one day invoke the resulting First Amendment to defend their freedom to exclude oil and gas from their portfolios financial.

But a group of sustainable investment funds argues that Texas’ 2021 anti-ESG law and 2022 blacklist, which calls for divestment from funds and firms deemed to be boycotting fossil fuels, punishes those businesses based on the content of their speech – and therefore violates them. The first amendment, the right to free speech.

Proponents of environmental, social and governance considerations in investment, as well as their critics, have each tried to cast the opposite side as dragging politics into business decisions that should be evaluated neutrally. The lawsuit filed last week by the American Council for Sustainable Business is the latest twist in that conflict, with the trade group arguing that Texas’ blacklisting of financial companies is a troubling government intrusion into private sector business.

At issue is Texas law that restricts state entities, including pension plans and K-12 school endowments, from investing in companies deemed hostile to the fossil fuel industry. Republican state Comptroller Glenn Hegar went further in 2022 when he announced a blacklist of more than 350 financial companies and investment funds that he accused of “boycotting” the energy industry.

Companies that invest with ESG principles are engaging in “doublespeak,” Hegar argued, and “using their financial clout to advance a social and political agenda.”

The 2021 law “allowed the comptroller to punish speech he dislikes,” the ASBC said in the complaint.

Skye Perryman, executive director of Democracy Forward, a legal organization that represents the ASBC, told me in an interview that the Texas law is “an improper and unconstitutional effort to politicize what should not be political.”

The case is based on legal precedent, she said, finding that “states cannot coerce companies or express themselves.”

The complaint alleges that potential government contractors, such as ASBC members Etho Capital and Our Sphere, which manage exchange-traded funds that exclude fossil fuels, were subjected to “politicized discrimination.”

“Indeed, viewpoint and content discrimination are the only bright lines in the controller’s application of the statute,” the lawsuit states.

Because the Texas law is vague and does not give companies due process to challenge its blacklisting, the suit claims, it not only violates the First Amendment, but also denies companies their 14th Amendment right to a trial fair.

At the heart of the plaintiffs’ argument is that sustainable investment is an unbiased business decision. But the lawsuit, filed in the Western District of Texas, also seeks to defend the free-speech rights of investment funds — and could test the consistency of a conservative court that has previously been friendly to corporate free-speech claims.

In general, conservatives have been far from consistent in arguing that corporations should be treated as constitutionally protected speech entities, Aziz Huq, a constitutional scholar at the University of Chicago Law School, told me.

For example, Huq said, Texas’ anti-ESG law “stands in stark contrast to the attitude conservatives have had toward corporate efforts to engage in electoral politics through donations.” In the 2010 Citizens United decision, for example, the Supreme Court struck down limits on corporate donations that political groups can accept.

defense stocks

ESG risk: knowns and unknowns

Over the past two years, Ukraine’s fight against Russia has sparked a rethinking of whether defense stockpiles should be considered sustainable.

ESG equity funds in Europe have more than doubled their exposure to arms companies since the start of 2022, according to Morningstar Direct, as governments have pushed for building a stronger defense industrial base. It doesn’t hurt that arms orders are booming.

For critics, the idea of ​​defense as an ESG investment is an oxymoron. Proponents, however, argue that national security underpins a viable climate and sustainable economy – which ESG portfolios claim to value. (Many investors distinguish conventional weapons from weapons restricted by international treaties, such as nuclear weapons and cluster munitions, and seek to exclude the latter).

What may get lost in the debate over whether missiles or fighter jets contribute to global social good, however, is the original premise of ESG investing: not preaching about good or bad, but recognizing emerging forms of risk and adjusting investor exposure accordingly.

We spoke to David Coombs, multi-asset manager at Rathbones, about how the UK wealth and investment management business is approaching defensive stocks. His analysis used the logic underlying the ESG investing thesis: that companies with controversial practices are likely to be targeted in ways that threaten their returns.

Like other forms of financial risk, he argued, risks associated with global conflict might be worth taking, but should be clearly identified.

Rathbones no longer added defense stocks to funds labeled as “sustainable”. But when doing an overall risk analysis for the funds he manages, Coombs said, “The ESG risk for defense is significantly reduced.”

In 2016, for example, Rathbones bought shares in Lockheed Martin. “We thought the ESG risk was very high, but with (US President Donald) Trump coming in and the impact we thought it might have on NATO, we felt it was a hedge against Trump’s foreign policy risk,” he said.

Following Russia’s full-scale invasion of Ukraine in 2022, Rathbones decided to continue betting on the importance of national security and specifically look for a European-based defense company. He eventually bought shares in French defense contractor Thales.

The risk of investing in big defense contractors is also tempered by congressional oversight of those companies — which includes export restrictions, Coombs argued. “Lockheed can’t go sell weapons to Belarus just because it wants to. So you have that element of governance dictated by the US government.”

“There will be people who disagree with the US government and to whom they sell weapons,” he added. “But just looking at it from an investment perspective, rather than a policy perspective, this (feels) like a known ESG risk.”

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