ESG Investing Legislation: Predictions for the 2023–2024 Legislative Session

Environmental, social, and governance (ESG) investing continues to be a hot-button issue as new state legislatures prepare for their next legislative session. The majority of US state legislative assemblies allow bills to be prefiled ahead of the new legislative session to introduce legislation prior to the beginning of the next session. State politicians often use the prefiling process as a way to demonstrate their top priorities ahead of a new session. Examining trends in prefiled bills can help identify the proverbial “canaries in the coal mine” indicating where the political winds will blow in an upcoming legislative session.

Below, we examine state-level legislation prefiled ahead of the start of 2023 legislative sessions and identify three key trends where we expect to see ESG investing legislative action at the state level. After the publication of this Insight, 26 states proposed new ESG-investing-related bills since the start of the 2023 legislative session. Many of these states have proposed multiple forms of ESG-investing bills—Oklahoma has 18 different versions of proposed ESG bills that would restrict ESG investing with state assets, and Texas has four different versions of proposed bills that would restrict ESG investing and one proposed bill that would encourage ESG investing.

KEY TRENDS FOR 2023

1. ESG Investing Remains a Hot Issue: Five states used their prefiling process to get ESG to the top of the legislative agenda.

Five states so far have seen ESG investing legislation proposed during the prefiling period: Arkansas (state legislators proposed an anti-ESG investing bill, HB 1049); Missouri (state legislators proposed four anti-ESG investing bills: SB 177, SB 316, SB 50, and SB 200); Oklahoma (one anti-ESG investing bill: SB 15); South Carolina (one anti-ESG investing bill: SB 111); and Texas (three anti-ESG bills: HB 982, HB 709, and HB 645, and one pro-ESG investing bill, HB 1091).

Texas’ mix of proposed ESG investing legislation highlights the polarization of this issue—while three of its proposed bills are anti-ESG investing bills that seek to limit the use of ESG, the fourth is a pro-ESG investing bill that would repeal SB 13, one of the country’s first anti-ESG investing bills enacted by Texas in 2021.

2. A New “Model” Bill on the Horizon Targets ESG Scores: Three states have prefiled legislation seeking to limit corporate “discrimination” based on ESG scores.

Three state legislatures (Arkansas, Missouri, and Texas) saw prefiled bills seeking to limit corporate discrimination based on ESG scores. This is a relatively new “type” of ESG investing bill. The 2021–2022 legislative session saw many almost identical proposed and adopted anti-ESG investing bills that followed two models. We analyzed those types of anti-ESG regulations in this Morgan Lewis ML BeneBits blog post and at length in this article. We classified the first “type” as “Boycott Bills,” which direct state entities to divest from and refuse to contract with companies that boycotted certain industries (fossil fuels, firearms, etc.). We classified the second “type” as “No-ESG Investment Bills,” which prohibit the use of state funds for the purpose of ESG or social investment.

The prefiled bills indicate that a third type of anti-ESG investment regulation may be trending in the 2023 legislative session, which we have coined “Prohibitions on ESG Discriminations.” These bills prohibit public entities from “discriminating” against individuals or other companies based on ESG scores or other value-based scores. This category would generally prohibit government entities from awarding contracts based on positive (or potentially negative) evaluations of ESG criteria.

Arkansas legislators prefiled one Prohibition on ESG Discrimination (HB 1049), whereas Texas and Missouri legislators each prefiled three different iterations (Texas’s versions are HB 982, HB 709, and HB 645; and Missouri’s versions are SB 316, SB 177, and SB 50).

This type of proposed regulation is not brand new, although it had been an outlier in the 2021–2022 legislative session. Missouri proposed this type of bill back in February 2022 with SB 1171, although it never received enough votes to make it out of the Senate committee (Missouri’s three different prefiled bills are all substantially similar to this one), and Pennsylvania proposed this type of bill in September 2022 with HB 2799. Now, with a total of four states proposing Prohibitions on ESG Discrimination, we expect to see other states following suit and considering these types of bills in the next legislative session.

3. If at First You Don’t Succeed…: Some states are recycling anti-ESG legislation that failed to pass in the prior legislative session.

While some states are proposing new forms of ESG investing bills, some states are trying again with identical legislation that failed in the prior legislative session. Members of the Missouri and Oklahoma state legislatures prefiled anti-ESG bills that are identical to proposed bills from earlier legislative sessions that failed to receive enough votes to be enacted into law. Missouri’s prefiled SB 177 is identical to the failed SB 1171 from the 2022 legislative session, and Oklahoma’s prefiled SB 15 is similar to its HB 3144, which died in the 2022 legislative session.

This trend indicates the importance of keeping in mind the unsuccessful anti-ESG legislation from the 2022 session. Although some states may have failed to enact those proposed bills into law in 2022, they may seek a second shot in the next legislative session.

Also noteworthy is the fact that many states that failed to enact anti-ESG legislation in 2022 resorted to other methods to enact other forms of anti-ESG regulation. For example, Arizona’s Boycott Bill, HB 2473, died in the Arizona House of Representatives in the spring of 2022, but the Arizona state treasurer issued a state-wide binding investment policy statement in August of 2022 that prohibits consideration of ESG factors in investment decision-making, in effect working around the failure to enact the Boycott Bill into law. Similarly, Indiana’s state legislature failed to pass its Boycott Bill, HB 1224, in the spring of 2022, but the Indiana attorney general issued a binding advisory opinion in September 2022 prohibiting the consideration of ESG factors in state investment decision-making. This trend also demonstrates the importance of keeping an eye on the states that have yet to pass anti-ESG legislation and noting that they may try again or find another method to institute anti-ESG regulations in the new year.

KEY TAKEAWAYS

The ESG investing space continues to be rife for regulatory change in 2023 and may impact a huge swath of the corporate market. While some of the ESG regulations explicitly target financial services companies only (see for example, Wyoming’s enacted HB 0236), many others, including the newest “type,” Prohibitions on ESG Discrimination, attempt to limit the focus on ESG factors by any business operating within the state (see, for example, Pennsylvania’s proposed HB 2799).

Notably, the state level ESG regulations with divestment provisions only apply to state funds and public retirement plans (federal law preempts the states from regulating private retirement plans, which we discuss at more length in this article). These new and proposed regulations tend to focus on investments made for “ethical” ESG purposes (e.g., divesting from oil and gas companies in order to respond to climate change concerns) and have implicit or explicit exceptions for the consideration of ESG factors for “financial” purposes (e.g., avoiding an investment in an issuer on the basis of potential regulatory risks associated with pollution).

In reviewing these new developments, investment managers and fiduciaries should carefully consider the role ESG considerations play in their investment programs and ensure that their ESG processes are clearly disclosed to their investors, understanding that considering ESG for “ethical” purposes may result in the application of some of these new and proposed regulations to the firm and/or its products.