On the Frontlines of the ESG Wars: Risk, the Profit Principle, and Investment Markets as a Policy Arena

 

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 I have been following the increasingly theatrical performance of  the ESG Wars.  That theatricality veils a much more important battle--the fight over the risk principle of economic activity, and the role of risk based innovation in  and through markets and collective activity (see here, here, here, here, and here). Environmental, Social, and Governmental assessment (ESG)--as a set of risk managing criteria, as an analytical mode of aligning economic activity with market expectations, law and norms,  and ESG as the embodiment of those norms themselves--appears to be an ideal candidate for a key conceptual vessel around which economic activity (and the markets through which they operate) may be recncieved through  the reconstitution of the notion of risk. To that end two distinct visions are now clearly emerging.

On the one side stands the old principles of markets based economic activity--one grounded in the acceptability of risk taking by those able to bear it, or those willing to endure it; the reward for which is measured in the value added of such activity captured through markets transactions--profit. That profit, in turn, is awarded to those who stood at the end of the line of payment--the residual holders of interests in the economic collective (today mostly equity holders). Here risk is measured as a function of reward.

On the other stands the emerging principles of compliance and public policy; of the extension of the state and its needs effectuated through the economic activity of collectives. This is grounded on the preservation of public values and thus of an aversion to the risk of their breach.  The reward for such activity is measured not by value added but by the measurable  extent to which such activity advances the state objectives toward which economic activity is bent. At its limit, value added--profit--is owed to and a reflection of the contribution of such activity toward the public policy manifested in state objectives. These objectives may either be reflected in the domestic law of a state or through its acquiescence in international law and norms (the case, for example, perhaps,  of the German Supply Chain Due Diligence Law--where the state did not even take the trouble to naturalize its impositions on national or jurisdictionally captured collectives).  

One of the most interesting battlefields on which these wars for the control of the signification of risk, and its instrumentalization as the means to shape cultures of economic activity (and the hierarchies of authority around them), is playing out in a most traditionally innocuous place--the definition of the role and objectives of fund fiduciaries. On the traditionalist side one has encountered  both a number of U.S. state officials seeking to resist federal policy that would permit consideration of exogenous (ESG) risk in investment decisions. They argue, in part, that ESG here is not merely about the scope of risk assessment, but rather its reshaping, and with that reshaping, the move toward the abandonment or diminution of the importance of the risk-reward-profit principal that seeks to impose the risk of failure on equity holders and compensate them for that risk by permitting the the right to recovery residual value added form collective activity. They would forbid consideration, even discretionary consideration, of risk factors not tied to reward. That is, the only permissible risk to be considered are risks to the maximization of the welfare of the collective.

Other jurisdiction have gone in the opposite direction.  They have seen in risk a potent instrument for the transformation of the imaginaries of the economic enterprise, and its convergence with the elaborate risk universe already constructed for the administrative apparatus of a state that increasingly sees itself as the embodiment of the vanguard elements of society. That vanguard must propel the rest forward; forward toward an ideal that is sometimes visible only to the collective that is the vanguard arranged within the apparatus of state organs. That imaginary increasingly demands that risk be measured not by its internal effects, but by its external effects--to individuals, communities, and public policy objectives which may be adversely affected by decisions around economic activity. Profit to internal stakeholders, then, might be tempered by the need to prevent or minimize damage to an identified set of outside stakeholder and measured by the prohibitions of international (human rights and sustainability) policies. 

It was inevitable, then, that in this context, and especially in the absence of international consensus and a growing appetite for national measures, that states would begin to both project their particular regulatory world views outward, and, at the same time, seek to protect their own activities against the outward projecting activities of other states. And so, as a bit of a publicity stunt--meant to generate at least 24 hours on the news cycle--and of course to reach out to key domestic constituencies, the German state of Baden-Württemberg

One of the richest regions in Europe’s biggest economy, and the home of Mercedes-Benz Group AG as well as Robert Bosch GmbH, adopted a law this year that puts investing sustainably on par with more traditional criteria such as profitability and liquidity. It’s a decision that may affect as much as a fifth of the state’s €17 billion ($18 billion) of holdings, as it pivots away from ESG laggards.

Few outside Germany paid much attention to the law when it was passed. But it turns out the legislation has international ramifications. That’s because the new environmental, social and good governance filters have resulted in US Treasuries ending up on an investing blacklist, due to America’s failure to ratify a number of treaties in areas including women’s rights and controversial weapons. Other nations to be singled out by the policy include Finland, Latvia and Greece. (US Treasuries Blacklisted by German State as ESG Law Takes Hold).

 It will be inevitable that as states choose sides, more and more of these disjunctions will emerge.  In a sense they are reflexive of the larger trajectories that great leaders have been at pains to deny--the growing decoupling of blocs of states along ideological lines. Indeed, this is consciously done, though admittedly at an initially crude level: "Arnim Emrich, the head of Baden-Württemberg's treasury and asset management unit, acknowledged to Bloomberg that banning certain investments based on international treaties is "kind of a blunt approach." (A German state refuses to buy Treasurys because the US doesn't meet its ESG standards).