president’s office Risk management, ESG, the Duty to Shareholders, and the Supreme Court MICHAEL P. AFFUSO, ESQ., PRESIDENT/CEO, NJBANKERS In recent years, Environmental, Social, and Governance (ESG) considerations have emerged as pivotal factors influencing the strategies and operations of businesses across various industries. In particular, the banking sector has witnessed a significant transformation, with ESG principles becoming part of decision-making processes. This shift was principally driven by regulatory action, with regulators having assumed a dual role of both regulating an industry, and attempting to channel the efforts of that industry into a lane which they deem beneficial. ESG advocates view banks as financial intermediaries and key contributors to sustainable development and societal well-being. As advocates have been appointed to top regulatory positions, ESG permeates the regulatory superstructure of financial services. For example, a recent Supreme Court case struck down a New York DFS rule focusing on reputational risk of institutions doing business with the NRA. In a 9-0 decision written by Justice Sotomayor, the court found that this type of regulatory action, though cloaked in risk management, actually had an illegal chilling effect on the First Amendment. Bankers are in the business of managing risks and serving the people and businesses in their marketplace. Assessing risks and balancing those risks is a key element in banking. One of the primary drivers behind the integration of ESG into the banking sector is the growing awareness of environmental risks. Community banks, especially, understand their local communities and are best suited to manage local environmental risks. Indeed, there is risk to lending in the Passaic River basin, Raritan River Basin, or the coastal and other littoral properties. Bankers routinely weigh these risks when lending money to borrowers, as do insurers. A risk based ESG model also calls for bankers to assess whether they should lend to the fossil fuel industry as a means of drying up sources of funding for a non-favored industry. In New Jersey, many people use fossil fuel to heat their homes and most use gasoline for locomotion. Under the guise of ESG, zealots want to dry up lending for home heating oil companies as well as to gasoline retailers, instead of allowing capital and lending markets to weigh the various risks in funding decisions. ESG policy creates situations where bankers will be forced to shift lending preferences toward the favored policy de jure. Some things to consider: oil and gas are bad and solar is good, but it is widely acknowledged that the fastest way to reduce carbon is to shift from coal to natural gas for electricity generation; solar is sustainable and ESG friendly, but little consideration is given to the degradation of the environment for sourcing the minerals for batteries or fabrication of the solar panels; wind is sustainable and ESG friendly, but the economics don’t work. Bankers will be whipsawed between whatever advocates deem is the best policy on a given day. While some may feel that this problem is not yet acute at community banks, like other targeted regulatory actions, this issue is likely to seep down into the community bank level in the future. ESG policies also push industries to shift focus from shareholders to “stakeholders” as defined by the regulatory superstructure and advocates. Banks are particularly committed to the communities in which they do business, but they also must balance this ethos against sustainability as a business. Sustainability in banking requires prudent lending and the ability to raise capital. Bankers must navigate the binary framework of environmentally friendly lending (good) and traditional lending (bad). While the social benefit to low interest lending to ESG friendly projects may be clear, the ability of the borrower to repay as well as the other costs to the institution must be balanced. It is unlikely that capital markets will look favorably on institutions that are over positioned in low profit endeavors. A healthy banking system, as well as a healthy economic system, requires investors to have faith in the institutions that they are investing in. A keystone of that faith are the fiduciary duties owed to shareholders. Cornell University Law School Legal Information Institute states: The duty of care is a fiduciary duty requiring directors and/or officers of a corporation to make decisions that pursue the corporation’s interests with reasonable diligence and prudence. This fiduciary duty is owed by directors and officers to the corporation, not the corporation’s stakeholders or broader society. While it is reasonable that financial institutions give attention to broader social constructs to ensure that acute stress is not visited upon them by regulators or customers, and thus harm shareholders, this cannot become the primary focus of any industry needing access to capital markets. Indeed, even BlackRock CEO Larry Fink, who stood at the vanguard of ESG, has voiced concerns that proposals were “over-reaching lacking economic merit” and “unlikely to help promote shareholder value.” The challenges to ESG principles are not only on the economics, they are also likely to reach the Supreme Court. Over the past several years, the Supreme Court has handed down landmark decisions in the May/June months. Recently, we have seen adjudication surrounding abortion rights, gun rights, affirmative action in universities, and the legality of the funding scheme of the CFPB. The court is poised to rule on a case which deals with Chevron deference, the doctrine of judicial deference given to administrative actions, holding that such judicial deference is appropriate where the agency’s answer was not unreasonable, so long as Congress had not spoken directly to the precise issue at question. Should the Court limit the scope of administrative action, it is likely that certain ESG rules promulgated by regulatory bodies will come into legal question. What should a banker do? Do what you are doing—do your best: know your customer and community, assess the risks and balance the risks. It is what you do and what you do best. 6 from the njbankers president’s office
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