One investment attorney offers his expertise and insights on the complexities surrounding ESG investment policies within state and municipal retirement plans
We spoke to Ethan Corey, a Senior Counsel at Eversheds Sutherland, about the nuances of various policy statements, the impact of state legislations, and the necessity of thorough review to grasp how investment policies are implemented and have evolved across different states.
Corey provides a comprehensive understanding of the challenges and considerations asset managers and proxy voting providers face in navigating the ever-changing landscape of investing in mandates that incorporate one or more environmental, social & governance (ESG) objectives.
Thomson Reuters Institute: What are the reasons for reviewing investment policy statements beyond the scope of state laws and regulations?
Ethan Corey: In many instances, a state will not have a law or regulation that addresses ESG investing, for any number of reasons. From a logistical perspective, even if a state has introduced one or more ESG bills, ESG legislation, like all other legislation, may not make it all the way through the state legislative process before the legislative session has ended. A bill may need to be reviewed by different committees, then considered by the full legislative body, then referred to the state’s other legislative body and then go through that body’s committees before being considered by the full body.
Even if both bodies pass the legislation, one body may have amended the other body’s version, which would require the bill to be reviewed and approved by a conference committee to iron out the differences, before that version is voted on by both bodies. Even if both bodies approve the conference committee version, the state’s governor still must approve it, and if the governor vetoes it, both bodies would be required to override the governor’s veto before it could become law.
Moreover, even if a state does have a law or regulation that addresses ESG investing, the pension plan may have provisions that address aspects of ESG investing not addressed by state law or regulation. For example, a state may have a law that prohibits the state or any of its agencies, subdivisions, or instrumentalities from entering contracts with companies that the state has determined to have unlawfully boycotted the firearms industry. The state employees’ retirement plan investment policy statement may separately require investment advisers and proxy voting advisers to consider only pecuniary factors (which are defined to exclude ESG factors) when managing the retirement plan’s assets or providing proxy voting recommendations to the retirement plan.
Thomson Reuters Institute: Do all of the states’ investment policy statements uniformly address ESG considerations?
Ethan Corey: While some state and municipal investment policy statements address ESG topics, not all of them do. And plans may organize ESG policies differently — while some plans include ESG policies within the main body of the investment policy statement, others may include ESG policies in an appendix or may have stand-alone ESG policies.
There are any number of reasons why a state or municipal pension policy statement would not address ESG topics. In some instances, it may be because the relevant state or municipality has enacted legislation or regulations that address ESG topics and consequently, the plan trustees may not believe that there is a need to separately address ESG topics. In other instances, the policy statement may have been drafted by a consultant hired by the plan. The parameters set forth by the plan to the consultant to guide the consultant’s drafting may not include any ESG topics.
While some state and municipal investment policy statements address ESG topics, not all of them do — and plans may organize ESG policies differently
In still other instances, particularly if the trustees believe that an investment policy that incorporates the prudent investor rule is broad enough to encompass investing techniques that apply ESG factors to optimize returns, the plan may believe that it is unnecessary to include specific ESG topics in an investment policy statement.
Not surprisingly, political considerations can also play a role, particularly if an elected official plays a significant role in the administration of a plan or in the appointment of its trustees.
Thomson Reuters Institute: Do all of a state’s retirement plans uniformly address ESG considerations?
Ethan Corey: It’s critical to study each plan within a given state on its own merits. For example, one state employee retirement plan may include a policy requiring investment advisers to consider ESG factors as part of their review of potential investments for the retirement plan, as well as their review of investments already being held by the retirement plan.
At the same time, another retirement plan within the state may require investment advisers to implement plans to divest from fossil fuel producers over the next 15 years. It is also possible for one retirement plan within a state to specifically address ESG investing in its investment policy statement while another retirement plan within the same state is silent on ESG investing, and a third retirement plan in the same state addresses proxy voting on ESG topics but does not address ESG investing topics.
There are even instances in which one state retirement plan prohibits plan assets from being used to take any action with a purpose of furthering social, political, or ideological interests and limits consultants to considering only those factors that relate to economic value and financial benefits to the plan, while a different retirement plan in the same state encourages investment managers to consider ESG factors as part of their investment analysis and requires periodic reports on the plan’s ESG efforts, methods, and results.
Thomson Reuters Institute: To what extent do ESG policies exhibit nuances beyond the primary types observed?
Ethan Corey: Indeed, there are nuances in ESG policies. Two policies that may be similarly worded may still have important differences. For example, there may be two policies that require investment advisers to take into account only pecuniary factors when managing plan assets. One policy may treat ESG factors as pecuniary factors if they are considered as part of a financial analysis of plan investments and potential investments. The other policy may treat ESG factors as per se not pecuniary factors, even if they are being used to assist in a financial analysis.
Indeed, there are nuances in ESG policies. Two policies that may be similarly worded may still have important differences.
Similarly, there may be two policies that prohibit plans from entering into agreements with financial institutions that have been determined to boycott fossil fuel producers. One policy may impose this prohibition without exception. The other policy may include an exception if application of the prohibition would eliminate any eligible counterparties or if remaining options were much more expensive. Or, one ESG policy may apply only to proxy voting advisors while another ESG policy may apply to both proxy voting advisors and investment advisers.
One ESG policy may require only that an investment adviser apply ESG factors in providing discretionary investment management services to a plan, while another policy may also require that the manager provider periodic reports on its ESG activities to the plan.
In closing, the United States’ landscape of enacted legislation, regulations, and investment policy statements potentially affecting financial services providers is complex and diverse. Consequently, asset managers and proxy voting providers would be wise to carefully study and develop a strong understanding of this ever-evolving area of asset management.
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