The ESG battle: 4 key states shaping regulatory discourse in the US (2024)

ESG is taking center ring of the ideological battle happening at the state level across the country. The fight has pitted liberal-leaning states like California and New York, which often support ESG-focused investment frameworks, against conservative-bent ones like Florida and Texas that are typically campaigning to ban consideration of ESG in its funds and policies.

With the upcoming presidential election and an impending climate disclosure rule from the Securities and Exchange Commission, both parties are doubling down on their respective stances, passing new bills and regulations that could impact how businesses approach their environmental, social and governance strategies.

Florida and Texas lead the state-level push against ESG

Several Republican politicians in Florida and Texas have become the national faces of the anti-ESG movement.

Under the direction of Gov. Ron DeSantis, Florida is leading the movement against ESG initiatives, looking to punish asset management firms who consider environmental, social and governance principles or have ESG funds.

BlackRock is one of the DeSantis administration’s favorite targets. The governor directed the state to divest $2 billion in assets from the Larry Fink-led firm for its ESG policies last December. Florida, however, still invests an estimated $12.9 billion with the company, according to research credit rating agency KBRA released last month.

DeSantis began expanding Florida’s stance in the arena earlier this year when he created a coalition of 19 states in March to restrict the use of ESG in investing at the state level. The Florida state legislature followed the governor’s lead and passed a bill prohibiting the use of ESG consideration by state or local governments in issuing bonds; banning any preference due to ESG factors or ratings in procurement; and outlawing consideration of social credit scores by banks. DeSantis signed it in May, shortly before announcing a run for the Republican presidential nomination.

When announcing the bill’s signing, DeSantis said the state will continue to take a national lead in a fight against banks and investors “who’ve colluded to inject woke ideology into the global marketplace.” As a candidate for higher office, he released a “Declaration of Economic Independence” where he pledges to end the use of ESG by investors should he be elected president.

“There will be no ideological litmus test for getting a loan, establishing a bank account, or running a business,” it says.

Though not an official member of DeSantis’ coalition, Texas is on a similar crusade against the use of ESG in investing. While Florida may be making the most noise, the Lone Star State was quicker to exercise its legislative power.

In January, Texas Attorney General Ken Paxton used legislative groundwork laid two years prior to prove the state’s pushback against ESG came with enforcement. Paxton — who was impeached and acquitted of corruption in the state legislature this year, but awaits criminal trial next April for securities fraud — accused CitiGroup of violating a 2021 state law prohibiting businesses from being government contractors if they have policies “that discriminate against or boycott firearm or ammunition companies.” The state agency overseeing the Texas-record $3.4 billion municipal bond dropped Citi and reconfigured the deal as a result.

Another 2021 law requires state pension fund managers to divest from institutions that “discriminate against or boycott fossil fuel companies.” BlackRock was among the initial 10 firms on the state comptroller’s list last year banned from doing business with the state, along with 348 mutual funds the state had to divest from. A June bill restricting state insurers from using ESG scores and metrics not based on “sound actuarial principles” or that don’t “bear a reasonable relationship to the expected loss and expense experience related to insurance risks” went into effect in September.

Florida and Texas may be the public faces of the anti-ESG movement, but there’s a broader resistance being led by Republicans in state houses and governors’ mansions across the nation. State attorneys general have also played key roles, serving as the legal muscle behind states’ efforts to restrict the consideration of ESG in investments.

Paxton joined AGs from 26 states in appealing the dismissal of a lawsuit that challenged a Labor Department rule allowing retirement fund managers to consider ESG factors. The Biden administration regulation was finalized this January, and the coalition’s lawsuit was initially tossed in September. However, led by Paxton and Utah AG Sean Reyes, the group said they’re willing to keep fighting the case all the way to the U.S. Supreme Court.

Victor Flatt, the environmental law chair at Case Western Reserve University, told ESG Dive he conceptually divides those with genuine concern about whether the inclusion of climate change and other ESG factors actually yields the greatest return on investments from those who oppose the principle as a result of the broader cultural movement.

“I think, from the perspective of an anti-ESG politician, it's like they feel like [ESG] is a house of cards that has just been built up and created to get policies in place that politically were not able to happen in the United States,” Flatt posited.

Jason Isaac, the director of the Texas Public Policy Foundation’s Life:Powered national initiative, told the House Ways and Means Committee last week that ESG targets “unequivocally” force companies to reconcile a distortion in decision-making with maximizing profits. Isaac, a former Republican Texas state representative, said three-quarters of the executives for S&P 500 companies have their compensation tied to ESG goals. Marlo Oaks, Utah state treasurer, at the same hearing, said some studies have shown ESG proxy measures to have a negative impact on financial returns.

“The proxy vote is one of the very important roles that an owner of a stock has,” Oaks told the committee. “They can exercise their right to vote their shares on issues that come before a corporation, and, unfortunately, this process is being hijacked.”

Chris Fidler, head of industry codes and standards for the CFA Institute, told ESG Dive he was worried about the types of anti-ESG legislation being advanced at state levels. He said he considers laws outright prohibiting the use of ESG considerations fall among the “most concerning.” Other bills that boycott businesses for building ESG into their operations “aren’t exactly new,” according to Fidler, and represent a return of local protectionist policies.

“Some states have proposed that you couldn't even … consider ESG information when you're making an investment decision. And that just kind of blows my mind,” Fidler said. “There's a fiduciary duty for [fund managers] to continue to take into account all relevant information, and you can't just tell people to ignore certain information because it doesn't agree with your political views.”

California and New York set blueprint for pro-ESG regulation

California and New York are on the opposite end of the spectrum as Florida and Texas, introducing several pieces of legislation over the past decade that promote ESG-aligned investments and taking regulatory action on related environmental and social issues.

California Gov. Gavin Newsom signed two major climate-related legislative measures — Senate Bill 253 and Senate Bill 261 — into law in October, which push for more transparency from large companies. SB 253 would require businesses operating in California with annual revenues exceeding $1 billion to report their greenhouse emissions each year, whereas SB 261 would require business entities with revenues exceeding $500 million to publicly disclose their climate-related financial risks and countermeasures.

Though California’s bills might not directly impact the SEC climate disclosure rule as it has already been drafted, experts believe they are likely to have a ripple effect on climate disclosures and investment policies in other states.

“With California under SB 261, as well as the SEC creating frameworks for governmental reporting of climate-related financial risks, other states may be more likely to also adopt their own disclosure requirements that complement the SEC rule,” said Allison Smith, an attorney at Stoel Rives LLP focused on environmental and energy law.

Shortly after approving the climate bills, Newsom also signed Senate Bill 54, requiring venture capital firms headquartered or operating significantly in the Golden State to annually report the number of diverse founders they invest in and disclose data about their race, sexual orientation, gender identity, disability and veteran status. This new bill, in particular, advocates for more social data disclosures — an aspect of ESG reporting that historically lags behind environmental and governance disclosures.

SB 54 follows the passage of Senate Bill 1162, a pay transparency law passed last year in California.

The blue leaning West Coast state, which has served as a harbinger for climate action, has made substantial moves to incorporate an ESG framework within both its state policies and investments over the last decade, according to KBRA.

California was the first state to adopt a cap-and-trade program to curb greenhouse gas emissions in 2013 and to ban the sale of new fossil fuel-powered vehicles by 2035 last year — a move that was followed by 17 other states, including New York, Pennsylvania, Colorado and Virginia.

However, Smith notes that though California has often been the “tip of the spear for state-level climate policy,” the recent momentum in greater transparency has been driven, at least in part, by market forces.

“The state’s foray into ESG with broader requirements for GHG emissions and climate-related financial risk disclosures is aligned with a wave of voluntary climate-related disclosures, and related voluntary emissions reduction goals, by large companies in the U.S. and abroad,” she said.

Climate regulations aside, California also has two of the nation’s largest state pension funds: the California Public Employees’ Retirement System and the California State Teachers’ Retirement System with $467 billion and $311 billion in assets, respectively, according to KBRA. Both funds actively integrate ESG issues into their investment decisions.

The California state Senate passed SB 252 in May, which would require both pension funds to stop investing in fossil fuels and liquidate close to $15 billion in holdings. However, the bill is currently pending in the state legislature, and its passage is unclear.

Following in California’s footsteps, New York also banned the sale of new fossil fuel-powered cars by 2035 and established a cap-and-trade program under the Regional Greenhouse Gas Initiative with other Northeastern states, such as Connecticut, Delaware and Massachusetts. The initiative aims to limit and reduce CO2 emissions from the power sector.

Aside from promoting green infrastructure, the Empire State has also incorporated an ESG investment framework within the New York State Common Retirement Fund, which is the third largest state pension fund in the U.S. with $254.1 billion in assets, according to KBRA. According to the fund’s investment philosophy, it considers ESG factors in its investment process “because they can influence both risks and returns.”

In 2020, New York State Comptroller Thomas DiNapoli announced that the retirement fund had set a goal of net-zero portfolio emissions by 2040, building on the Climate Action Plan introduced in 2019 that sets minimum standards to determine if a company is prepared for a low carbon-transition. Minimum standards for the thermal coal industry led to the divestment of 22 coal companies. In 2022, the fund divested from half of its shale oil and gas companies, selling $238 million worth of stock and debt across 21 businesses.

This year, the New York City Employees’ Retirement System, the nation’s fourth largest pension fund, and the Teachers’ Retirement System of the City of New York set a goal of net zero emissions in their investment portfolios by 2040 as well.

New York has also taken measures to increase ESG-related disclosures. Earlier this year, the state Senate proposed Senate Bill S5437, which would require applicable corporations to annually prepare a climate-related financial risk report, and Senate Bill S636A, which would require certain companies and corporations to report their employee’s gender ,race and ethnicity data. Both bills have yet to be passed by the Senate.

While California and New York are often leading the way, 19 states have enacted laws encouraging the consideration of ESG factors within state investment strategies, as of August 2023, per KBRA.

Illinois and Maryland, for example, both passed legislation requiring state and local entities to consider sustainability and climate risk when identifying investment opportunities. Meanwhile, New Mexico and Oregon have introduced policies that establish guidelines on the incorporation of ESG factors for state investments and how to formally integrate ESG factors into fund management policy, respectively.

Where the rest of the battleground stands

Together, these four states continue to blaze the path for both sides of the ESG battle, with potential lasting impacts on the state and federal level.

“While state climate legislation could serve as a blueprint for federal climate regulation, such as SEC climate disclosures, a more likely outcome is that state legislation will put pressure on the SEC to move forward with their climate disclosure laws,” said Nithya Das, chief legal officer at Diligent, a software company that provides businesses with ESG and compliance solutions.

Das also noted that such legislation from California and New York would encourage other climate and social responsibility policies at a federal level as “varying state-by-state requirements may become untenable for business without federal standardization.”

“Ultimately, climate disclosure obligations and social responsibility policies are unavoidable,” she said. “It is not a question of ‘if’ but rather ‘when.’”

Recent legislation in states beyond Florida and Texas, however, would disagree with Das’ assessment.

At least 25 anti-ESG bills passed in 12 states where Republicans control the state legislatures this year, and 19 states have at least one bill opposing the principle on their books, according to S&P Global Market Intelligence. Utah alone passed five bills in the 2023 session.

Despite the volume of action, Dave Curran, co-chair of law firm Paul, Weiss, Rifkind, Wharton & Garrison LLP’s sustainability and ESG advisory practice, said there has been “very little” enforcement or disruption for businesses from the laws. He added that companies are continuing to integrate ESG into their operations because consumers and investors have shown a persistent demand for it.

“Lots of talk, lots of headlines, but no real action,” Curran said. “There have been absolutely some changes, and the messaging has affected how companies interact with [the ESG] ecosystem. But for the most part, companies are forging ahead, doing exactly what they were doing prior to the political upheaval in this country.”