The increasingly global nature of business and cross-border regulatory compliance means that companies across the world are coalescing around the Environmental Social Governance (ESG) agenda. But in the US, ESG finds itself caught in the firing line between Republican culture wars and has become the focus of intense scepticism and scrutiny.

From South Africa to Finland, ESG is rapidly becoming accepted as a ‘must have’ for corporate credibility – a kitemark for good governance and a business’s overall success. Companies are embracing the new opportunities offered by ESG, such as a more diverse and inclusive workforce, as well as acknowledging the longer-term economic value of mitigating climate change risks.

In contrast, many US firms are facing an anti-ESG movement or ‘war on ESG’. Highly politicised by nature, the backlash is affecting business mostly in Republican states where the introduction of anti-ESG bills is rising significantly. At least seven states have taken anti-ESG stances presented as ‘anti-boycott’ measures that aim to prevent state entities from investing in companies boycotting the fossil fuel industry. These initiatives have also taken the form of bills that restrict state funds from being used for ESG investment. Law firms have a unique perspective in the conflict as advisors on ESG and as businesses themselves.

On 4 November 2022, 51 large US and global law firms were directly approached in a letter from Republican Senators raising anti-trust risks associated with participation in ESG initiatives:

‘Over the coming months and years, congress will increasingly use its oversight powers to scrutinize the institutionalized antitrust violations being committed in the name of ESG and refer those violations to the FTC and the Department of Justice,’ it warned.

Republican-majority efforts to prevent investment managers from incorporating ESG into decision-making came to a head in March 2023 when President Biden issued his first veto. This rejected the 50-46 cleared bill ensuring that citizens who wish to access ESG investments through employer retirement plans can do so.

Some analysis indicates more than 250 anti-ESG bills have been proposed this year, in over 40 US states, but what are the potential implications from a legal perspective? I spoke with partners at Hogan Lovells, Clifford Chance, and Ropes & Gray, among others, to better understand how lawyers and their clients are navigating the increasingly complex legislative landscape in the US and the potential impact on America’s green transition.

Conflicting obligations

To understand the impact of anti-ESG legislation on clients, it is important to underscore the varied legislative landscape in which corporations operate within the US. Under the federal system, both federal enforcement agencies and state attorneys general operate simultaneously and because states are not required to act in conjunction with federal enforcers, state actions are sometimes at odds with those at federal level. From an antitrust perspective, as referred to in the Republican Senators’ letter, coordinated ESG efforts equate to climate cartels, elevating the issue from a cultural debate to a potential antitrust risk.

US-based companies, especially those with a global footprint, are under international pressure to commit publicly to sustainability and emissions reduction measures from the full range of stakeholders whilst having to negotiate this highly complex, domestic legislative environment. Steve Nickelsburg, partner at Clifford Chance and member of the Global Business and Human Rights Risk team, highlights the multiple and opposing pressures clients are facing, and the reality that some are considering whether they must set up separate red and blue businesses as a way of dealing with competing demands.

But which clients are being most affected by these whipsaw public policy shifts? According to Michael Littenberg, global head of Ropes & Gray’s ESG, CSR and Business and Human Rights practice, large financial institutions and asset managers are primarily caught in the ‘ESG crossfire’ between red and blue states, with many having received subpoenas, being asked to testify, or being placed on blacklists by red states.

An obvious example of this is Florida’s $2bn divestment from Blackrock in December 2022. The financial giant embodies the polarity of the issue, being both a leader for ESG and climate change investing whilst refusing to halt investments in coal, oil, and gas, infuriating both Republican politicians and environmentalists alike.

Asset managers have a fiduciary duty requiring them to both abide by their client’s directive, and to provide the best risk-adjusted terms for the said directive. This means clients have steering control on their investment choices, and companies, such as Blackrock, are therefore obliged to offer sustainable investment opportunities for those clients wanting to go down this route, as well as traditional investment products.

We are already seeing the effects of climate change, the extreme weather that comes with it and the potential to weaken global economic growth and financial stability. This propels climate action far beyond ‘the morally correct thing to do’ to something necessitating engagement at board level as a fiduciary responsibility. As a result, complying with anti-ESG laws could be seen as going against asset managers’ core duties.

Globally, companies are becoming increasingly cautious when disclosing their ESG strategies due to regulatory efforts against ‘greenwashing’. Authorities such as the US Federal Trade Commission (FTC) are looking at environmental claims with increased scrutiny. Following the FTC’s review of the ‘Guides for the Use of Environmental Claims,’ it announced plans to update guidance, requiring, for example, more specific information to support claims of the recyclability of products. This specifically targets companies misleading customers and gaining an unfair competitive advantage in the market.

Nickelsburg points out the combined effect of the anti-ESG rhetoric in the US and fear of greenwashing allegations is ‘green bleaching’ or ‘green hushing’, i.e., ‘institutions putting their heads down and saying nothing’. As of June 2023, Blackrock Boss, Larry Fink claims he has stopped using the term ESG altogether. For Nickelsburg, a possible silver lining could be that greenwashing fears foster more rigor as businesses need to be able to ensure there is substance behind ESG claims.

While the politicisation of ESG appears to be strongest in the US, Adrian Walker, global Head of ESG at Hogan Lovells, cautions: ‘The backlash is a significant market development, and it has a global reach with impacts on UK and EU businesses too.’

The role of law firms

To best advise clients on ESG amid state level regulatory variations, firms must be forward-looking and keep track of both the short-term and long-term trends when it comes to ESG and climate-related regulations. Littenberg points to Ropes & Gray’s ESG legislation tracking page as a useful tool for clients to stay up to date on the ongoing developments when it comes to ESG investing at state level.

Upcoming federal requirements reveal a shift from the typically voluntary and market-led climate action we see in the US. The upcoming SEC’s climate disclosure rules are expected to come into force in autumn 2023 and will require public companies to disclose their climate impact as well as their governance, risk management and climate risk strategy. Lawyers will need not only to educate and prepare their clients on these requirements but continue to look ahead at what regulations and disclosures are in the pipeline.

Perhaps law firms with operations on ‘both sides of the pond’ are at an advantage here, being able to directly draw from the knowledge and experience of their European counterparts when preparing clients for the regulations expected to come.

Scot Anderson, US corporate and finance partner at Hogan Lovells, emphasises the importance of ESG for any project’s

success, and the necessity of those on both sides of the issue to understand that getting a project off the ground requires community and stakeholder engagement and advocacy. Businesses that do not cover ESG in their proposals will likely experience more barriers. Anderson states: ‘Even ESG sceptics understand the soft skills required to make a project durable’. Advising in this way shifts ESG from an issue of corporate responsibility to everyday business.

Just as it makes economic sense for firms’ clients to take ESG into consideration as part of their wider business strategy, the economic growth associated with practicing ESG as a law firm cannot be ignored. Law firms creating an ESG practice could have a competitive edge against others. It is plausible that firms who respond to client demand and can provide a one-stop-shop when it comes to advice on ESG-related operational and financial risks will see increased revenue.

A bump in the road? ESG is undoubtedly a political hot potato in the US and its polarising nature has led to some US-based organisations avoiding commenting on it altogether for fear of provoking either side of the debate. ‘Green hushing’ has also, in part, been prompted by stricter greenwashing legislation.

It’s important to recognise that the ESG backlash in the US does not exist within a vacuum. ESG and the green transition are global phenomena and therefore influence and are influenced by a variety of circumstances.

Coincidently (or perhaps not) the ‘war on ESG’ came shortly after Putin’s invasion of Ukraine which shook the global economy and caused a surge in energy prices. This presented huge financial motivation for oil and gas companies to increase production, and some were willing to undermine or entirely roll back their climate targets to prioritise this. Also unsurprisingly, fossil fuel companies are providing financial backing to anti-ESG activist groups.

According to Nickelsburg, the anti ESG agenda is ‘a counterweight in a huge discussion and is having an impact in discussions at board level.’ Significantly however, Nickelsburg points out that its potential impact will be overwhelmed by the huge subsidies and money flows in the opposite direction.

In August 2022, the US House of Representatives passed the pioneering Inflation Reduction Act (IRA) expected to spur a tsunami of capital into clean energy and climate change investments – approximately $3 trillion – through the expansion and extension of tax credits. This will be a key driver of the green transition in the US, providing a powerful financial incentive for a private sector to move away from carbon intensive infrastructure. As suggested by Nickelsburg, it is highly unlikely that the backlash will derail this industry shift.

In addition to the major economic impetus from the IRA, reporting directives show no signs of slowing in Europe (especially the EU). The enhanced climate disclosures set by the EU due January 2024 require businesses to disclose their indirect or ‘Scope 3’ emissions. These requirements therefore call on US-based companies embedded in EU supply chains to accurately report on their own climate impact, and in turn pressure them to take meaningful actions to reduce this.

Anderson states, ‘ESG is too deeply embedded for the backlash to truly hinder it’, and according to Littenberg: ‘US companies strive to be global leaders, or at least remain globally competitive. This requires them to embrace innovation and be part of the green transition’. Law firms in turn will need to keep a close eye on state and federal-level ESG legislation and be forward-looking in terms of their own commitments to help clients navigate the politics of ESG and stay competitive as a firm.