Does ESG investing count as free speech?

Welcome back. Arguments for what sustainable finance means are getting . . . creative.

For today’s newsletter, I looked at a lawsuit brought in Texas by a business group representing sustainable investment funds, which argues that the state’s refusal to work with financial firms deemed hostile to ESG infringes on those funds’ free speech rights.

Plus, the debate over whether stock in military contractors should be considered an ESG investment.

Thanks for reading.

backlash to esg

Business group sues Texas officials over anti-ESG law

When James Madison sat down to draft the US Bill of Rights in 1789, the staunch civil libertarian cannot have imagined that investors would one day invoke the resulting First Amendment to defend their freedom to exclude oil and gas from their financial portfolios.

But a group of sustainable investment funds is arguing that Texas’s 2021 anti-ESG law and 2022 blacklist, which call for divestment from funds and firms deemed to be boycotting fossil fuels, punish those businesses based on the content of their speech — and thereby violate their First Amendment right to free expression.

Proponents of environmental, social and governance considerations in investing, as well as their critics, have each sought to cast the opposing side as dragging politics into business decisions that ought to be evaluated neutrally. The lawsuit filed last week by the American Sustainable Business Council is the latest twist in that conflict, with the trade group arguing that Texas’s blacklisting of some financial companies is a worrisome intrusion of government into private-sector affairs.

At issue is Texas’s law restricting state entities, including pension plans and the K-12 school endowment, from investing in companies deemed hostile to the fossil fuel industry. The state’s Republican comptroller Glenn Hegar went further in 2022 when he announced a blacklist of more than 350 financial companies and investment funds he accused of “boycotting” the energy industry.

Companies investing with ESG principles engage in “doublespeak”, Hegar argued, and “use their financial clout to push a social and political agenda.”

The 2021 law “has allowed the Comptroller to punish speech he dislikes,” ASBC said in the complaint.

Skye Perryman, chief executive of Democracy Forward, a legal organisation representing ASBC, told me in an interview that the Texas law is “an improper and unconstitutional effort to politicise what should not be political”.

The case draws on legal precedent, she said, finding that “states cannot coerce companies or chill [their] expression”.

The complaint argues that would-be government contractors such as ASBC members Etho Capital and Our Sphere, which run exchange traded funds that exclude fossil fuels, have been subject to “politicised viewpoint discrimination”.

“Indeed, viewpoint and content-based discrimination are the only clear through-lines in the Comptroller’s enforcement of the statute,” the suit reads.

Because the Texas law is vague and does not offer companies a fair process to contest their blacklisting, the suit argues, it not only violates the First Amendment, but also denies companies their 14th Amendment right to due process.

At the core of the plaintiffs’ argument is that sustainable investment is an impartial business decision. But the suit, brought in the Western District of Texas, also seeks to defend the free speech rights of investment funds — and could test the consistency of a conservative court that has previously been friendly to corporate free speech claims.

In general, conservatives have been far from consistent about when they argue that corporations should be treated as entities with constitutionally protected speech, Aziz Huq, a constitutional scholar at the University of Chicago Law School, told me.

For example, Huq said, Texas’s anti-ESG law “is in stark contrast with the attitude that conservatives have had towards corporate efforts to engage in electoral politics through donations”. In the 2010 Citizens United ruling, for example, the Supreme Court removed limits on corporate donations that political groups can accept.

defence stocks

ESG risk: the knowns and unknowns

Over the past two years, Ukraine’s fight against Russia has sparked a rethink over whether defence stocks should count as sustainable.

ESG-linked equity funds in Europe have more than doubled their exposure to arms companies since early 2022, according to Morningstar Direct, as governments have argued for building a stronger defence industrial base. It doesn’t hurt that weapons orders are booming.

To critics, the idea of defence as an ESG investment is an oxymoron. Supporters, however, say that national security underpins a liveable climate and a sustainable economy — which ESG portfolios claim to value. (Many investors distinguish conventional weapons from weapons restricted by international treaties, such as nuclear weapons and cluster munitions, and aim to exclude the latter).

What can get lost in the debate over whether rockets or fighter jets contribute to global social good, however, is the original premise of ESG investing: not sermonising on right or wrong, but recognising emerging forms of risk, and adjusting investors’ exposure accordingly.

I spoke to David Coombs, multi-asset manager at Rathbones, about how the UK-based wealth and investment management business is approaching defence stocks. His analysis used the logic that underpins the ESG investment thesis: that companies with controversial practices are likely to be targeted in ways that threaten their returns.

Like other forms of financial risk, he argued, the risks associated with global conflict might be worth taking on — but should be clearly identified.

Rathbones has stopped short of adding defence stocks to funds labelled as “sustainable”. But when performing general risk analysis across the funds he manages, Coombs said: “ESG risk for defence is reducing significantly.”

In 2016, for example, Rathbones bought stock in Lockheed Martin. “We thought ESG risk was super high, but with [US President Donald] Trump coming in, and the impact we thought that might have on Nato, we felt it was a hedge on Trump foreign policy risk,” he said.

Following Russia’s 2022 full-scale invasion of Ukraine, Rathbones decided to make a further bet on the importance of national security — and to look specifically for a European-headquartered defence company. It ultimately bought shares of French defence contractor Thales.

The risk of investing in major defence contractors is also tempered by congressional oversight of these companies — which includes export restrictions, Coombs argued. “Lockheed can’t just go and sell arms to Belarus just because it wants to. So you’ve got that element of governance dictated by the US government.”

“There will be people who disagree with the US government and who they sell arms to,” he added. “But purely looking from an investment perspective, rather than a political perspective, that [feels] like a known ESG risk.”

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