Corporate law departments have to strike a tricky balance between pro-ESG forces among some stakeholders and customers and anti-ESG among some state government legislatures
A backlash to companies investing in environmental, social & governance (ESG) initiatives has swept through many U.S. statehouses over the past three years. Twenty-two states have adopted anti-ESG related laws; and while some states have incorporated ESG into their investment strategies, but many others forbid fiduciaries from using ESG considerations in investing state funds.
In fact, some states have enacted broader laws prohibiting boycotts of industries perceived to be out of favor in regards to ESG principles. Meanwhile, other states, notably California, are passing laws informed by ESG considerations.
State governments take action against ESG
The most widely publicized moves by state governments have been to preclude the use of ESG considerations in the investment strategies of state funds, including pensions. For example, an Arkansas law passed earlier this year prevents public pension fund fiduciaries from using nonpecuniary factors in making investment decisions, including ESG or a “similarly oriented consideration.”
Detering government entities from doing business with companies using boycotts is another tactic used by state governments. In at least eight states, companies conducting or soliciting business from the state may not “boycott” or “discriminate against” industries including fossil fuels and firearms. Advocates claim Net Zero commitments and other ESG-related pledges are a boycott that harms local industries. In Kentucky, a 2022 law directs the state treasurer to maintain a list of public financial companies that have engaged with energy boycotts and to divest from them if they do not cease the boycott within specified time frames. The list, released this January, contains 11 financial companies.
In addition, some states have prohibited broader business practices. For example, Florida enacted what may be the broadest anti-ESG law to date. Under the law, ESG factors are classified as a “social credit score,” referencing government programs in China unrelated to ESG, and their use is considered an unsafe and unsound practice by state-chartered financial institutions.
Antitrust issues in the use of ESG factors for investment is another avenue for attacks on ESG by elected officials. Last year, a group of attorneys general signed letters to major institutional investors and climate pledge organizations claiming ESG efforts raise antitrust concerns and may violate consumer protection laws. The letters usually request additional information from the recipient on climate pledges.
States implementing ESG principles
In the opposite direction, a smaller number of states are integrating ESG principles into investments and the law, and there are a range of policy actions. Large companies doing business in California will have to publicly disclose their annual greenhouse gas (GHG) emissions and submit climate-related financial risk reports as soon as 2026 due to two groundbreaking laws passed recently by the state. The laws are broader than proposed Securities and Exchange Commission (SEC) disclosure rules, requiring, for example, disclosure of Scope 3 emissions without the materiality requirement in the proposed SEC rules.
Unlike anti-ESG laws, the California laws apply to entities over a certain size — one billion in total revenues for GHG disclosures, $500 million for climate-related risk disclosures — and are not tied to state licensing or contracting.
In another embrace of ESG, many states are applying ESG factors as considerations in state investment. For example, Maryland law directs its state retirement and pension board to integrate climate risk considerations in investment policies and practices. Also, states are introducing climate risk policy guidance, such as the New York Department of Financial Services’ introduction of climate-related risk management guidance for banks and mortgage institutions in 2022.
A wait-and-see approach is best guidance
These new laws and the surrounding media coverage are generating concern among some in-house lawyers. Generally, these laws beg more questions than they answer when it comes to compliance. Most businesses will not face immediate compliance challenges from anti-ESG laws; however, the California disclosure laws require costly reporting on a relatively short timeline.
For anti-ESG laws in particular, there is not a lot of substantive advice to give to most businesses until states start applying the laws and clarify fundamental issues, namely the broad or vague definitions used in anti-ESG statutes. At the same time, there are some actions that in-house lawyers should be considering. One key action for corporate legal departments is to advise management that the focus of many anti-ESG laws is on the management of state funds. Most companies will not have to make immediate changes on account of these laws. For most businesses, a wait-and-see approach is the best option.
In-house lawyers at state-regulated insurers and state-chartered banks or insurers in states that have passed relevant laws, however, may have to be more proactive by reviewing what data the company labels as ESG. A 2023 Texas state law notes that insurers may not use an ESG “model, score, factor, or standard” to set different rates. The exact definition of ESG in this context is unclear, so what the company labels as ESG matters.
Companies should flag any third-party models, scores, factors, or standards marketed as ESG for review. Also, they should review any ESG-related pledges or commitments. Flag anything that looks like a boycott, including pledges not to use fossil fuels or invest in firearms companies. This does not mean the pledges should necessarily be abandoned, just identified and examined.
Companies should also determine if and how the data or models labeled as ESG are used to make business decisions covered under the relevant law. This may include decisions on setting insurance rates or issuing loans. Laws banning the use of ESG factors contain exceptions for using relevant information that is also used in ESG evaluations for decisions made based on sound actuarial principles.
When reviewing risks from an anti-ESG statute, pay attention to how the state is implementing the law. State treasurers, attorneys general, and regulators are all sources of crucial guidance. Companies doing business with state and local governmental entities that require an antiboycott certification may need to undertake a review. Many of the states passing antiboycott laws on ESG topics like fossil fuels already have similar antiboycott certification laws, such as those relating to Israel, so past practices may serve as a guide. Each state antiboycott law has a different scope, so each state needs a separate review.
The exception to this wait-and-see posture is California. Large businesses doing business in the state will have to comply with increased disclosure requirements, including Scope 1, 2, and 3 GHG emissions starting in 2026. Larger businesses should position themselves to create compliance plans that take into account California along with the SEC, European Union, and industry group requirements.
In the face of anti-ESG laws and partisan sentiment, don’t panic is the guiding principle for now. Most businesses have yet to face the consequences of these laws, but a proactive approach to reviewing how ESG considerations inform business decisions is prudent.