What the ESG veto makes clear

This week President Biden issued his first veto and accompanied it with predictable denunciations of Republicans who had backed the measure. Biden vetoed a congressional action on ESG and pension asset management.

First, a simple explainer is in order. Historically, pension assets were required to be managed according to the principle of fiduciary obligations to retirees. This meant that pension administrators had one job, to look out for the financial benefits of the workers in the plan. Pensions were not designed to be alloyed with extraneous factors such as social justice or political causes. The legislation that enshrined this firmly into American pension law was passed in the 1970s and is called ERISA.

But over time, political activists pressured pension plans to dilute that fiduciary obligation with political and social objectives. For example, Jesse Jackson pressured asset managers to favor bonds focused on inner-city infrastructure projects. Second Amendment critics pushed for the exclusion of gun manufacturers. Global warming alarmists pushed against the use of oil and gas. More recently, these activists have been pushing companies to treat pro-life laws as risk factors to avoid. All of this generally flies under the progressive flag of ESG (Environmental, Social, Governance) investing.

ESG investing took root mainly in the pension plans of progressive states, especially California’s CALPERS fund, but with such large clients, Wall Street cashed in by launching many ESG funds, some clearly identified as such and some not. ESG was great for them, as it justified higher fees. But there was no proof that ESG investing led to greater investment returns for the funds. As London Business School professor Alex Edmans points out in Grow the Pie, in general terms “socially responsible” funds have historically underperformed, and that was work he had done before 2022, a blow-out year for oil and gas companies and a blow-up year for ESG-darling tech companies. A lot has changed since then. 

In 2020 Labor Secretary Eugene Scalia led an effort to counter the drift into politicized investing and to reinstate the clear intent of the ERISA laws, which was to put retirees’ financial benefit as the sole focus of pension management. I was asked to offer input into that rule-making process. Common sense prevailed, and retirees were protected by the new policy.

But there has been some plain-and-simple misinformation about the changes, which the president recapitulated this week. Claims that consideration of ESG was made illegal are flatly false. ESG risk factors could be considered, but only implemented if they were shown to be of financial benefit to retirees. The rule change under Scalia simply made clear that the pension managers had to shoulder the burden of proof. Want to exclude oil companies? First, explain precisely why you think that will help a retired school teacher pay her bills.

Biden reversed all of that, waving ESG management through the checkpoint with no actual checking. Excluding oil in the name of climate risk was automatically deemed legitimate with no rigorous analysis showing performance enhancement, let alone enough to overcome the added drag of higher fees.

Congressional Republicans and moderate Democrats voted to overturn Biden’s assist to the ESG industry. This week, Biden vetoed it, relieving the Blackrocks and Vanguards of the world from any legal obligation to rigorously demonstrate that an upsell to ESG management would help retirees.

West Virginia Senator Joe Manchin blasted Biden, as did mainstream (not just MAGA) Republicans. This has something to do with West Virginia being an energy producing state, but there’s something deeper here. Blue-collar Democrats used to be the party of pensions. There would never have been an ERISA if not for the union Democrats acting to protect pensioners from Wall Street. But now, the reversal could not be more complete. The conflict between the interest groups could not have been more clear. Gigantic money management firms have staked reputation and capital on ESG ideology and its higher fees. Pensioners’ interest is in the financial returns of the pension plans. Biden made clear just which one he chose.

Joe Biden’s constituents live in New York and work for Blackrock. Joe Manchin’s constituents live in West Virginia and work for black rocks, which they pull out of mines with backbreaking labor. They deserve as good a shot at a decent retirement as anyone else.