Advocating for ESG

I applied for this project several times throughout the last semester, and here I come, with my wonderful teammate, to this project. We are preparing to help our client fight against Texas Anti-ESG law (S.B. No. 13).

Analysis of the objectives of this project

The initially provided objective of the project is to examine how the latest Texas ESG law impacts the retirement system as our client is one of the pension funds in Texas. I’ll break it down by analyzing the law and from the perspectives of the client which I learned in the initial interactions with them.

The overview of the law

SB No. 13, “An ACT relating to contracts with and investments in companies that boycott certain energy companies” requires a state governmental entity to divest from companies that “boycott” energy companies. “Boycott energy company” means, “without an ordinary business purpose, refusing to deal with, terminating business activities with, or otherwise taking any action that is intended to penalize, inflict economic harm on, or limit commercial relations with the company: because (A) invests in or assists in the exploration, production, utilization, transportation, sale, or manufacturing of fossil fuel-based energy; or (B) does business with a company described by Paragraph (A)”. As you can see from this definition, it is quite broad.

The Comptroller of Texas is to list all companies that boycott energy companies and update it to provide to each state governmental entity. Then each state governmental entity has to notify the comptroller of the listed companies in which the entity owns direct holdings or indirect holdings. For these companies, the entity must notify them they are on the list and subject to divestment after the expiration of a certain period defined by the law. The listed companies must cease “boycotting” energy companies within 90 days after the notice or they will suffer divestment from the state governmental entity as it is dictated by the law to divest.

However, the state entities may delay the schedule for divestment to the extent that the state governmental entity determines, in the state governmental entity’s good faith judgment, and consistent with the entity’s fiduciary duty, that divestment from listed companies will likely result in a loss in value or a benchmark deviation.

The political background and the client’s strategy

Who is against the law? With global warming and many natural disasters more conspicuous in these days, the value of ESG companies and ESG investment seems evident to many. Our client is one of them. I attended a conference co- hosted by the client and other related funds that suffer from Anti-ESG laws in other states. The president of our client made a speech, articulating her resolution to fight against the law. She emphasized the importance of ESG investment to the participants of the conference. Another point made was the fiduciary duty fund managers have. In other words, fund managers have to act in the best interest of the fund they are in charge of. Anti-ESG laws would limit the freedom in investment decisions and violate the fiduciary duty. The president at the conference and the client staff in the first meeting with us said that we are to help them prove it leads to a violation of fiduciary duty and overturn the law.

Who supports this law? Supporters of course include energy companies in Texas and their employees. According to the client (and our finance expert classmate), after COVID-19, stock prices of energy companies soared because of energy shortages. However, before COVID-19, the stock performance of energy companies was inferior to those of the other companies. Some investors of Texas energy companies see this after-COVID trend as one of the last opportunities to harness their holdings. According to the client, these investors include legislators and some citizens. For them, it is as much a personal issue as a public issue.

Given the fact that the anti-ESG law is of personal interest to people in the legislative branch, it will not be effective to just claim that the law is not good for the environment. They may or may not care, but they probably will not care enough to prioritize the environmental benefit. Instead, we have to focus on the financial loss the fund suffers or how small the benefits supporters of the law enjoy would be.

A deeper dive into the objectives and research questions

So far, the client has mentioned three layers of objectives: illustrating the financial loss the fund will suffer, measuring the impact of the law on their pension system, and overturning the law. However, these objectives seem to face the law from different angles and ideally require different outputs.

First, if our research succeeds in illustrating the financial loss the fund will suffer, the client can use our outputs to claim that the law conflicts with their fiduciary duty. In this case, they will apply for the exception set by the law where they prove that they will suffer the financial loss and get exempted from the restriction. This will save the client from the law and possibly be useful in convincing the legislators that the law is problematic. However, this potential output alone will not prove the overall picture of the financial loss caused by the law in various entities.

Second, the law’s implication on their pension system will inform the members of the funds how harmful the law can be in a concrete way. According to the client, the members receive $2,900 a month as their pension after their retirement. They rely on their pension to live comfortably after their retirement. Illustrating the impact of the law in such a way as “It will decrease the amount of the money you receive by $~~ in ~~ years” will help the client engage their members more in their movement to fight against the law.

Third, to overturn the law, while the potential outputs discussed above will all be functional, the client is likely to need additional materials. To show that the law will damage the financial stability of various state government entities, a general analysis of the profitability of ESG investments compared with non-ESG investments would be important. If we could focus more on the profitability of ESG investments in Texas, it would be nicer. Another possible approach would be to show how little the law benefits the investors of the Texas energy companies. Though state governmental entities possess huge funds, the impact their divestment from ESG companies has on the share prices of energy companies may be not large enough to benefit the shareholders substantially. This can contribute to the persuasion of people in the legislative branch.

Going Forward: narrowing down the research question and deliverables

Even though some of the potential outputs above are not directly required by the client, we should not exclude these potential directions yet. If that serves the client better, we should think about working on it. However, at the same time, we have a very limited time of one semester to work on the issue. It is unrealistic to think that we can work on all of these in an even way. Going forward, we should further deepen our conversation with the client and narrow down the scope of our research and our deliverables. We have a long way to go, but I am excited to go on this journey with my wonderful teammates.