Should US lawmakers be getting involved in fossil fuel divestment decisions?

What do investors and lawyers think of the growing trend for banning or forcing divestment?

US state legislatures are emerging as the new battleground for fossil fuel divestment, in a trend that has pleased few. 

Over the past year, Democrats in New York State, Colorado, New Jersey, Maine and Massachusetts have sought to direct asset owners that run public money to begin identifying and exiting investments in oil and gas.

Lawmakers have argued that the proposed interventions are about safeguarding investment returns, rather than being politically motivated. 

New York State Senator Liz Krueger, who is sponsoring one such bill, said recently that divesting from oil, gas and coal producers is crucial to prevent a “rapid loss of value”, noting that the valuation of state pension investments in fossil fuels had already dropped by $22bn since 2008. In neighbouring New Jersey, a similar bill includes a clause allowing the state to reinvest in fossil fuel companies in a scenario where state pension funds lose out on returns as a result of divestment.

But the trend cuts both ways, with Republicans legislators also moving to shield the fossil fuel industry. Earlier this month, Texas passed a bill requiring the state‘s four pension funds to stop investing in firms that boycott fossil fuels, on the grounds that “oil and gas is the lifeblood of the Texas economy”. Similar bills are being considered by the North Dakota and Alaska legislatures. And the movement extends beyond the US: Australia’s parliament is currently running an inquiry into the impact of fossil fuel exclusions on the country’s economy, and considering the possibility of regulatory intervention.

There is evidence that divesting fossil fuels does not harm – and may even boost – pension returns. Studies by BlackRock and US consultants Meketa, commissioned by New York City, both concluded that investment funds experienced a modest improvement in performance and no negative financial impacts from such exclusions.  The push for divestment can also be linked to growing concerns over the unwillingness of some oil and gas producers to commit to making a Net Zero transition, despite intense shareholder pressure.

Still, there is broad support for at least some investors to keep engaging with the fossil fuel industry. Keith Johnson, Co-Head of Institutional Investment Services at law firm Reinhart Boerner Van Deuren, believes that – while divestment may be a reasonable option for smaller investors who do not have much sway with a company’s management – larger funds have more resources and are therefore better positioned to conduct successful, targeted stewardship.

Instead of a one-size-fits-all approach for the entire market, Johnson says, legislators should focus on clarifying fiduciary responsibilities with regards to all systemic financial risks, not just climate change, and allow pension administrators to make their own decisions based on the circumstances of each portfolio.

"It can be counterproductive to take a narrow, short-term approach to policy intervention by only focusing on one area of risk,” he adds, warning against “ignoring other, long-term pecuniary effects of the cross-industry relationships between investment decisions and future environmental, societal and economic stability.” 

Even asset owners with existing fossil-divestment plans are worried that this legal approach may not be in the interest of beneficiaries, and could lead to further political interference. 

New York State Comptroller Thomas DiNapoli already has a five-year plan to divest the state’s $226bn pension assets from laggard fossil fuel producers, for example, but he could be forced to sell off holdings in all of the 200 largest listed oil companies by next year if Senator Krueger’s divestment bill is passed.

“Legislating public funds' specific investments opens the door to politicising decisions and removing the flexibility needed to prudently manage investments in order to pay pension benefits,” DiNapoli tells RI. 

“Divestment remains a last resort for the New York State Common Retirement Fund, reserved for investments that pose significant, sustained risks that are unlikely to be addressed by any other means, which is a determination that must be made by the fund's investment professionals, not legislative mandates,” he says. 

Others oppose legislative intervention on ideological grounds, branding it ‘un-American’. 

“For investors, having governments dictating investment decisions feels like a blunt instrument – particularly in the US where the economy has thrived based on the idea of free markets and capitalism,” says Betty Huber, who co-leads ESG and Environmental Transactions at Wall Street law firm Davis Polk.

“Another concern is that this approach will drive a further wedge into US politics,” she continues. “It is important that whichever approach is taken is the most economically efficient and avoids unnecessary political upheaval.”

An alternative course of action is to encourage state asset owners to vote out company directors who fail to manage climate risk properly. Shareholder advocacy group Majority Action has worked with state treasurers from Illinois, Vermont and Connecticut to adopt proxy voting policies enabling them to do just that, having spearheaded a successful campaign to oust climate skeptic Lee Raymond from the board of JPMorgan in 2020.

Lisa Lindsley, Majority Action’s Director of Investor Engagement, believes that there are other areas where legislation is needed, such as addressing greenwashing in ESG funds. Recently, research showed that some major ‘low-carbon’ investment products, including offerings from BlackRock, had high exposure to coal and oil. 

“If state legislators were really interested in moving the dial, they could encourage state-funded pension schemes to scrutinise their manager’s investment products to ensure they match up to their stated environmental objectives,” says Lindsley. 

Additional reporting by Paul Hodgson.