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How Corporate Boards Can Avoid ESG Investing Pitfalls

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George L. Strobel II is Partner, Co-Founder & Co-CEO of Monarch Private Capital.

Corporate boards are under intense pressure from shareholders and other constituents to invest in ways they can tout their environmental, social and governance (ESG) achievements. Inaction is not an option for most companies. Yet many boards are paralyzed in taking positive steps, fearing public scrutiny of those investments from both the political left and right could harm their company’s reputation and credibility. Is there a path through these political minefields for ESG-conscious boards?

Heightened Regulatory Scrutiny Facing ESG Investing

As more companies seek to brandish their ESG credentials by investing in funds that promote their ESG focus, many face increased scrutiny, becoming the target of criticism and even allegations of greenwashing and fraud. Regulators are moving to penalize firms engaging in “greenwashing” and related offenses that make false or exaggerated claims about their ESG investing practices.

In May, German authorities raided the offices of Deutsche Bank and its subsidiary DWS under allegations that it exaggerated the ESG profiles of some of its investment products. The S&P 500 recently removed Tesla from its ESG index partly due to claims of racial discrimination.

However, companies like Exxon Mobil and JPMorgan Chase made the list, prompting a public outcry from Tesla CEO Elon Musk, calling ESG a “scam.” BNY Mellon Investment Advisor Inc. paid a $1.5 million penalty to settle charges brought by the U.S. Securities and Exchange Commission (SEC) for their ESG claims. Goldman Sachs Group Inc. is the newest subject of SEC investigation.

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Concurrently, the SEC is exploring the possibility of requiring more detailed disclosures from companies regarding climate-related risks and ESG claims. A proposed rule would require companies to significantly increase their reporting on climate risks, including disclosure of their greenhouse gas emissions, environmental risks and the strategies used to address them.

These allegations and intensified scrutiny create uncertainty around the actual environmental or social benefits an investor can assert with respect to ESG funds.

Increasing Political ESG Backlash

In response to the financial sector’s expanding integration of ESG metrics, GOP lawmakers are pushing back, calling for new anti-ESG legislation. Some legislators are even blacklisting asset managers and financial institutions in their states, claiming their investment advice is environmentally focused and bans investments in fossil fuel-producing companies.

BlackRock, the world’s largest asset manager and a key supporter of ESG, has been a major target of this campaign. Texas Senator Ted Cruz blamed BlackRock CEO Larry Fink for rising gas prices in May, declaring “massive and inappropriate ESG pressure” as the reason for the nationwide price hike. In January, West Virginia’s Board of Treasury Investment dropped BlackRock funds from its portfolio for their embrace of ESG investing. The state legislature later passed a bill blacklisting financial institutions divesting from or limiting their investments in fossil fuels.

In March, Texas Comptroller Glenn Hegar asked BlackRock and nearly 20 other banks and financial services providers for their investment strategies for oil, natural gas and coal. This comes after Texas Governor Greg Abbott signed into law last year a measure that threatens companies “boycotting” the fossil fuel industry with the loss of state contracts and investments from Texas pension funds.

In April, the American Legislative Exchange Council released a model policy called the State Government Employee Retirement Protection Act, claiming to “protect pensioners from politically driven investment strategies.” The organization says ESG investing strategies shrink investment returns in the long term, hurting retirees and taxpayers. The policy requires plan sponsors for state and local pension funds to evaluate investments only on pecuniary issues, prohibiting considerations of environmental or social factors.

While rolled back by the Biden administration, the Labor Department under the Trump administration installed similar rules precluding administrators of public pension plans from considering ESG factors in their investment decisions. It would not be a stretch for some legislators to assert that ESG investments, regardless of their relationship to a company’s core businesses, might violate fiduciary duties owed to its shareholders under state law. The assertion would be that corporate funds are not being used to maximize shareholder returns.

Solution For Corporate Executives

So, how can corporate executives traverse these undercurrents while undertaking investments that demonstrate their commitment to being good corporate citizens?

The obvious solution is for companies to make direct investments in projects with positive ESG dynamics. This eliminates regulatory concerns if the benefits of those investments aren’t overstated and, as long as they’re profitable, avoids censure from the right.

Direct investing in environmental and social causes typically involves investing in renewable energy, low-income housing or historic renovations. A direct investment can take two forms: as a developer or as a tax equity investor. Investing as a developer of these programs is illogical for most companies. Returns are speculative and typically low. Moreover, the skills required for developing these activities are well outside the core competencies of most corporations. This is not a formula for corporate success.

Tax equity investments avoid the pitfalls of acting as a developer, offering predictable market-rate returns with low risk and requiring little to no expertise in the underlying projects. Unlike other investments, tax equity investments don’t demand a company’s scarce discretionary capital. Instead, they are funded almost entirely through a corporation’s federal tax liability. In terms of maximizing shareholder value, any company owing federal tax fails to maximize corporate cash flow and net worth if they don’t make tax equity investments.

ESG benefits of tax equity investments are readily ascertainable and quantifiable, whether it’s clean energy produced, homes built or jobs created. To add creditability, firms should engage one of the numerous third-party firms qualified to validate such results. Third-party validation will minimize risks of regulatory or other public assertions of exaggerated ESG claims.

Tax equity investments provide corporations with a noncontroversial approach to making positive environmental and social impacts. These accomplishments are far less susceptible to regulatory scrutiny and public criticism and avoid claims from the political right of squandering precious corporate capital. Corporate executives would be well served to consider tax equity investments to meet their ESG agendas.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.


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