Closing Thoughts

We have arrived at the end of the semester. It was a pleasure to work on ESG legislation at such a timely moment in national and state level politics. The fact that we had such a receptive client made the journey even more enjoyable.

As an individual, I was able to explore my interest in the theories that underpin ESG, reconciling shareholder primacy and stakeholderism. Beyond theory, I learned how ESG is implemented in financial markets, and received quantitatively and qualitatively by investors and beneficiaries. Moving into group work, it was helpful to play into each other’s strengths. With one person in charge of client relations and external communications, another in charge of financial analysis, and the final in charge of deliverables, we were able to bring to the client a final product that was impactful.

Now on our findings. Again, we were asked to evaluate the impact of a Texas law passed targeting banks that have ESG policies against fossil fuels, Bills 13 & 19 effective September 1, 2021. Specifically, the Law prohibits pension funds and other state entities from doing business with these “ESG companies”. This is the first take away: we are grappling with the impact of an enforceable law, not a legislative proposal under review.

We need to answer, what long-term effect could the policy have on the financial health of the retirement system? It was immediately incredible to understand the magnitude of impacted funds. There are currently over 5,500 of these state and local government-sponsored pension plans, with close to 21 million participants and $4 trillion in assets. While the funds impacted by this law are worth approximately $330 billion, it’s unclear how much of those assets are invested in companies that would be considered to be “boycotting” the fossil fuel industry. And, importantly, similar legislation is cropping up around the country. In Indiana, a report found anti-ESG legislation would have a $7 billion impact in foregone returns for state pensions over 10 years. Kansas found $3.6 billion. And, West Virginia found as much as $20 million annually. We suspected the impact would be in similar orders of magnitude.

A quick aside: while we were agnostic in our financial analysis, we had spent the semester talking with experts on ESG principles. Some shared: “It is proven that ESG outperforms non-ESG investment in the long-term.” Others retorted, “These states have Republican representatives who are free-market supporters. We should emphasize ESG is a free-market solution.” Others, supported that, “Only 6% of return is based on security selection. What drives allocation is driven by non-diversifiable factors, including price levels, in marketplace, driven by risk in market overall. Climate change is also pervasive. It affects all industries.” In other words, we were fielding tough criticism of the law and its financial impact.

In our modeling of the cost impact, we had some assumptions. First, we decided on several types of financial impact from the law: impact incurred by the divestment from companies and a fund listed by Texas Comptroller as boycotting energy and gas companies”; impact expected if Texas Comptroller enforces the law more rigorously; impact generally expected for refraining from investing in ESG companies. Then we had to work within the confines of several assumptions about the retirement system: the current system of defined benefit payout to retirees does not change (retirees have contracts where they are to receive a fixed amount every month as long as they live); system revenues continues to mainly come from member contributions, state appropriations, and investment returns; and the state will not compensate the damage caused by the law with an increased amount of state appropriations.

This being said, and without discussing sensitive information, we benchmarked system returns annually and over ten years and ran divestment scenarios from the listed companies and found implied impacts on returns. In some cases, i.e. Credit Suisse Group AG, we found positive impact from divestment, granted this is an exceptional case because of the company’s recently declared bankruptcy. For other scenarios, we found low impact (either positive or negative) because they didn’t far out or underperform industry standards. But, for some, scenarios, including the evaluation of foregone returns from BlackRock according to 10-year YTD change averages, the impact to the retirement system was very large.

Ultimately, after months of working with our client, they were pleased with the framework of our analysis and offered after our deliverables to continue working on this together with added depth and attention to detail. We covered a lot of ground together, but on such an expansive topic, there is still more to go.