You can’t reverse the ESG trend anymore

There is more and more regulation coming to banks and nonfinancial companies on all matters ESG. Just like many others, I think much of that regulation is an ill-thought-out one-size-fits-all exercise that creates a lot of extra work without providing many benefits. But we also must be aware that at least for now, this trend is here to stay, and trying to roll back regulations is costly in all kinds of unintended ways.

In the United States, we recently saw the supreme Court roll back the authority of the Environmental Protection Agency (EPA) to set and enforce emissions reduction targets. That was done based on the legal argument that such targets must be set by the legislator, not an unelected government agency. One can debate for a long time whether that is the right argument but it is clear that there will be costs associated with the reduced power of the EPA. These costs will come in the form of more water and air pollution which will directly affect the health of the people living in affected areas and will cost health insurers and taxpayers a lot of money.

To see how trying to roll back environmental efforts can backfire one has to look at Texas. On 1 September 2021 Texas introduced two laws that prohibited banks from bidding for public debt (mostly municipal bonds issues) if they had policies in place to divest from the oil and gas or the gun industry. As one lawmaker put it: “boycott Texas and we boycott you”.

Guess what, as a result of the laws, the biggest US banks withdrew from the Texas municipal bond market almost overnight and stopped bidding for bonds. The chart below shows the share of muni bond underwriting by banks targeted by the new legislation. There is one spike in 2022 (red circle in the chart) which was Citi underwriting a $1.2bn loan to Dallas/Fort Worth Airport which was exempt from the law.

Share of underwriting of Texas muni bonds by banks affected by anti-ESG legislation

Source: Garrett and Ivanov (2022)

But by boycotting banks that have ESG divestment rules the competition for municipal bond issues dropped. And where there is less competition, prices rise. In this case, borrowing costs for Texas municipalities rose. According to a study by Daniel Garrett and Ivan Ivanov the additional annual costs for Texas taxpayers from higher interest payments and bank fees are some $445m. Apparently, it is quite expensive to boycott ESG efforts.