National Review Online, September 30th, 2022

With environmental, social and governance (ESG) investing — a profoundly political “discipline” in which actual or prospective portfolio companies are measured against a varying selection of environmental, social and governance metrics — finally coming under the fire that it deserves, its advocates are rushing to its defense, many of them seemingly outraged that a political agenda has attracted the attention of elected politicians who disagree with it.

I wrote about this topic in a Capital Letter in August, and then followed up a week or two later in another Capital Letter after Michael Bloomberg had entered the fray. Among other issues, he contended that Republican critics of ESG didn’t understand what he called “investing 101.” He also suggested that conservatives were lackeys of fossil fuel companies, but we can pass over that.

A few days later, Tom Steyer, another billionaire activist and failed presidential candidate, took a harsher tack in the Independent, claiming that some Republican politicians were acting like “anti-capitalists.”

Steyer:

Republican lawmakers in Texas, Florida, and West Virginia are forcing their own brand of “political correctness” on the people of their states – denying them the opportunity to both make profitable investments and save the planet.

If Republicans are indeed denying them the opportunity to make maximum risk-adjusted profits, that would be a mistake.

However, it is entirely reasonable for such lawmakers to stipulate that it is inappropriate for those managing state pensions funds to be guided by anything other than financial return. If investment managers can demonstrate that looking at issues that fall within the vaguely defined E, S, or G could legitimately be of relevance to maximizing risk-adjusted return, they should be able to do just that.

But if ESG compels, say, an investor to rule out investing in businesses just because they are supposedly climate-unfriendly, that investor will then have a smaller pool of investments in which to go looking for return. There are certainly investment managers who believe that a degree of pre-screening to narrow the range of potential investments they will consider will enhance return both for the added investment discipline it brings and as a time management device. But those pre-screenings are typically based on quantitative requirements (for example, that a stock should generate a free cash flow yield above a certain amount) and directly linked to their view of what will make investors money.

This, however, is not.

From the Office of the New York State Comptroller (February 2022):

The New York State Common Retirement Fund (Fund) will restrict investments in 21 shale oil and gas producing companies, including Pioneer Natural Resources Co., Hess Corp. and Chesapeake Energy Corp., that have failed to demonstrate they are prepared for the transition to a low-carbon economy, New York State Comptroller Thomas P. DiNapoli, trustee of the Fund, announced today.

These restrictions are part of DiNapoli’s comprehensive Climate Action Plan to address investment risks from climate change and his commitment to transition the Fund’s investment portfolio to net zero greenhouse gas emissions by 2040.

“As market forces and new policies drive the energy transition, we must align our investments with a profitable and dynamic future,” DiNapoli said. “The shale oil and gas industry faces numerous obstacles going forward that pose risks to its financial performance. To protect the state pension fund, we are restricting investments in companies that we believe are unprepared to adapt to a low-carbon future.”

The oil and gas industry, including shale oil and gas companies, has been named by the Financial Stability Board’s Task Force on Climate-related Financial Disclosure (TCFD) as an industry that may be most affected by climate change and the transition to the emerging net zero economy.

And New York is by no means alone. But the reality is that even if there is a transition to net-zero by 2050 — something that, in the absence of technologies that do not yet exist or a major change in the willingness of electorates to vote for their own impoverishment, is by no means assured — there will still be plenty of time to make money from investments in fossil-fuel companies. And that ignores the potential profits to be made from investing in companies that sell fossil fuel products to those countries with little interest in joining in the same “transition.” So, for New York’s retirement fund to remove such companies (with others to follow) from investment consideration has nothing to do with investment return and everything to do with the pursuit of policy objectives using other people’s money.

Steyer asks, “Why should politicians determine what sectors experience economic growth? Isn’t that what the Soviets did? How’d that work out?”

Good question.

I wonder how he’d describe then what it is that the New York State Comptroller (an elected official) is doing. I also wonder how he’d describe the measures taken in Europe and, now California, to both bribe and (partly) force individuals (by phasing in bans of the sale of new internal combustion engine vehicles) to buy electric vehicles. Internal combustion engines won out over the horse and, for that matter, steam cars, because they were, for obvious reasons, consumers’ preferred choice. No one had to ban the horse or the steam car.

Steyer argues that climate change — or, as he prefers to put it, the climate “crisis” — offers the potential for immense financial return “as corporate bottom lines drive the demand for climate technologies.” And indeed, even if he may exaggerate the extent of the “crisis,” the fear of climate change will likely have something of the same effect. If you believe that free markets work — as Steyer purports to do — companies and investors will identify those climate-related opportunities and invest in them. They will not need ESG to help them do so, and nor will any state “bans” on ESG stop them from making such investments. From this perspective, ESG — or in this case, the E — has no purpose, beyond providing an effective mechanism to allow countless rent-seekers to make a buck or three. Worse, if companies feel that they have to make certain types of investment in order to satisfy the E, that is not only an invitation to capital destruction, but also the opposite of what a free marketeer should want.

Steyer writes that “industries need to acknowledge the risks they face, including climate-related risks. Identifying and avoiding risk means looking at data that helps the bottom line.” True enough, but, if we look at this on a financial basis, industries will, for the most part, struggle to find that risk. To go over, once again, the ground that has been well-covered by economist John Cochrane and HSBC heretic Stuart Kirk (neither man a “denier”), there is no evidence to suggest that, as a rule, climate change represents any material investment risk on the normal investment or lending time horizon. The exception to that are the risks posed by climate-based lawfare, regulatory, or legislative changes. Those should be priced in, but how to do so is not straightforward. However, assuming that Steyer may well favor such changes, he might find it difficult to draw attention to the risks they pose. Bloomberg was similarly silent on this issue, and it’s easy to understand why. As I have noted before, “certain arguments are too circular to be rolled out too far.”

What’s more, while companies and investors are far from perfect at predicting risk, they generally do a better job of it than third parties, because it is in their self-interest to do so. The global financial crisis provides an instructive example of how an attempt by outsiders, in this case bank regulators, to define and (indirectly) manage risk can go awry. Among the many causes of that crisis was an attempt by regulators to try to quantify degrees of risk for banks. To oversimplify, loans to real estate (and derivatives based on them) were deemed to be less risky than many other forms of lending, a classification that provided perverse financial incentives for banks to push more money in real estate’s direction. None of this is to deny that many banks behaved irresponsibly or, for that matter, that banks, particularly the largest, can, if run poorly, do immense damage to the economy. And sensible bank regulation has a valuable role to play. Nevertheless, the backstory to the global financial crisis reveals that there is a need on the part of would-be regulators (whether in the public or the private sector), to show a little humility when it comes to trying to quantify risk. But that humility is strikingly absent from climate policymakers.

And there’s something else. While the failure of banks, as alluded to above, can represent a systemic risk to the economy, that of the vast majority of companies cannot. In the case of most businesses, an error in assessing the cost of any climate risk they face may result in suffering for them and their shareholders. But, in just about every case, the impact on the broader economy of the pain to those companies will be somewhere between zero and trivial. Under those circumstances it is hard to see the basis for any regulatory intervention by the state or its agencies or its corporatist auxiliaries in the investment world. Steyer writes that, “the proposed SEC rule regarding climate-related disclosures helps asset managers live up to their fiduciary responsibilities.” Not quite, but what it will do (if it survives the legal challenge that is sure to follow intact) is impose a vast, expensive and unnecessary regulatory burden on the corporate sector: creating an enormous business opportunity for litigation lawyers and other parasites. But how that will benefit investors is a mystery.

Steyer writes:

Across the globe, other countries have observed the historic opportunity that climate investing offers – and they’re going after it. Last year, Chinese climate funds more than doubled their assets, growing to $47 billion in 2021, while Europe almost doubled to $325 billion. When Republican lawmakers stick their heads in the sand, they place the US at a distinct disadvantage.

Given the contribution that Europe’s climate policies have made to its current energy mess, citing the approach over there is, perhaps not the way to go. As for the Chinese regime, its insouciance with regard to the climate “crisis” is evident, to take one example, from its pursuit of new coal plants. China does invest in renewables, and extensively so, but the reason for that is two-fold. The first is as the regime’s desire to achieve something somewhat akin to autarky (or self-sufficiency, to use a more polite term) in broad sectors of the economy. It has nothing to do with climate change. The second is that Beijing has spotted the demand in the West for “climate-friendly” products. That this may well end up leaving the West reliant on China for key products of the future has not escaped the regime’s notice. Putin did pretty well with natural gas, so why not try to pull off the trick in other areas?

Steyer concludes:

[I]f we want to keep our economic leadership in the world, we must position ourselves to tackle the climate crisis with every tool at our disposal. We don’t have to get into politics — it’s just the smart thing to do.

To argue that tackling the climate “crisis” is essential if the U.S. is to preserve its economic leadership in the world is, at the least, debatable. And if tackling it means following a trajectory that puts undue reliance on the unreliable (wind and solar) and throws away the competitive (and geopolitical) advantage offered by American oil and gas reserves — not to mention pushing billions of dollars into centrally planned investment — doing so is a way to destroy American economic leadership, not preserve it.

Then, of course, there is the small question of who “we” are. To write that “we must position to tackle the climate crisis with every tool at our disposal” looks like a call for harnessed capitalism. That should come as no surprise, because ESG, stakeholder capitalism and their kin are all examples of a harnessed capitalism unrelated to free markets. And to claim that to achieve these aims, “we don’t have to get into politics” is thoroughly disingenuous”: Steyer’s “we” are already in it, and they should not be surprised that elected politicians with differing views are pushing back. And for that matter, the fact that they are, if not always perfectly, pushing back to defend the rights of free markets and shareholder rights is something to be welcomed, not condemned.