Banks and ESG

During a recent appearance on a popular American podcast, the prominent venture capitalist and cryptocurrency investor Marc Andreessen stoked controversy by accusing the U.S. government—and financial regulators in particular—of ‘terrorizing’ and attempting to ‘de-bank’ disfavored individuals and industries. To followers of the debate around banks’ consideration of environmental, social, and governance (or ‘ESG’) factors in business and regulatory policies, this was an escalation of a fight against so-called ‘woke’ banking. It was an important signal that the rhetoric surrounding ESG issues in banking is likely to become increasingly heated during the administration of President-elect Donald Trump. The incoming leadership of the House Committee on Financial Services and Federal Deposit Insurance Corporation have both signalled their intent to focus on de-banking and ESG issues. In anticipation of the incoming administration’s hostility toward ESG, the Federal Reserve has withdrawn from the international coalition of central banks dedicated to addressing the financial risks of climate change and the six largest U.S. banks have withdrawn from the voluntary financial industry alliance committed to achieving a net-zero carbon emitting economy. ESG and banking is reaching an inflection point.

In a working paper, I respond to the growing salience of banking and ESG by setting out the factual record behind this debate and considering the implications of some recent legal developments for the present and future of ESG in banking. The paper offers three principal—and counterintuitive—insights. First, anti-ESG efforts pose a greater threat of politicizing financial regulation than efforts to address climate-related financial risks and other regulatory and supervisory initiatives targeted by ESG opponents. Second, enacting sweeping anti-ESG measures would undermine the core legal authorities through which banking agencies examine, supervise, and regulate banks. Finally, ESG banking proponents should cabin their claims regarding the permissibility of ESG considerations within the provenance of banking law, rather than pursuing constitutional arguments like the First Amendment claims in National Rifle Association v. Vullo.

The roots of the banking and ESG debate arose in substantial part out of two developments: the Obama administration era effort to address payment fraud known as ‘Operation Choke Point’ that implicated certain industries—including firearms, payday lending, gambling, tobacco, and even coin dealing—and the trend of voluntary commitments by some U.S. banks to adjust their business policies in response to the epidemic of gun violence, the threat of climate change, and other societal challenges. Trump administration regulators, conservative state legislatures and executives, and conservative members of the U.S. Congress responded to these developments by accusing banks of ‘discrimination’ and ‘redlining.’

Ironically, the remedy for this alleged discrimination has constituted its own form of discrimination. Motivated by partisan politics, the participants in the anti-ESG backlash have employed extralegal federal regulations, sweeping state banking laws, and Congressional oversight to target legitimate business decisions and supervisory and regulatory actions. Through state-constructed blacklists, legislative jawboning, law enforcement investigations, and other tactics, ESG opponents have attempted to force banks to continue doing business with energy companies, firearms businesses, and other industries, entities, and individuals that fall into certain ideological categories.

It is within this context that the US Supreme Court decided two cases that implicate banking and ESG during its recent October 2023 term. In National Rifle Association v. Vullo, the Court clarified the circumstances under which the exercise of financial regulatory and supervisory authorities could constitute impermissible viewpoint-based coercion. At its essence, Vullo reinforces the principle that the First Amendment to the U.S. Constitution ‘prohibits government officials from wielding their power selectively to punish or suppress speech, directly or ... through private intermediaries’, Then, in Cantero v. Bank of America, the Court clarified the scope of federal banking laws’ preemption of state law under the Constitution’s Supremacy Clause, articulating the standard as a ‘practical assessment of the nature and degree of the interference caused by a state law’.

Many of the entities backing anti-ESG efforts supported the National Rifle Association (NRA)’s claims of regulatory overreach and celebrated the NRA’s victory over New York’s Department of Financial Services in Vullo. The cryptocurrency (or ‘crypto’) industry recently joined the fray, adopting anti-ESG rhetoric to assail federal bank regulators’ efforts to address the safety and soundness and illicit financing risks that crypto activities pose to banks. The crypto platform Coinbase responded by filing a lawsuit alleging that regulators are engaged in ‘Operation Chokepoint 2.0’ against the crypto industry in violation of the principles articulated in Vullo.

As the paper’s analysis lays out, however, the import of the Supreme Court’s decisions is not what it might seem to be at first blush. Instead, under Vullo, anti-ESG efforts likely constitute themselves viewpoint-base discrimination that violates the First Amendment. In addition state anti-ESG laws that apply to national banks are likely preempted by the National Bank Act because they significantly interfere with national banking powers under Cantero.

Seen in this light, it becomes clear that the anti-ESG movement is not what it claims to be. It does not seek equal access to the banking system for all. Its claim to victimhood notwithstanding, the anti-ESG movement employs legally questionable measures in an attempt to ensure certain ideological and parochial causes—such as fossil fuels, gun manufacturers, private prison companies, and so on—are deserving of financial access and protection while others—including communities affected by climate change and traditionally marginalized racial and gender groups—are not. In other words, they are engaged in the exactly the type of partisan project that they claim to be fighting.

While spelling trouble for the legality of many of the anti-ESG efforts to date, the narrow and fact-bound analyses in Vullo and Cantero sidestep broader questions about the scope of permissible ESG-related bank regulation and supervision. As a result, they preserve federal banking agencies’ capacious authorities to regulate banks in areas that both implicate ESG considerations and are consistent with their statutory powers under federal banking law. Banking agencies can supervise financial institutions on the basis of climate-related financial risks, reputational risk, antidiscrimination, compliance risks, and safety and soundness—for now.

This leads to the paper’s second insight: if the anti-ESG movement were to gain significant traction, particularly at the federal level in the U.S., it could cause collateral damage that reaches well beyond guns and fossil fuels. The most aggressive forms of anti-ESG measures would interfere with banking agencies’ foundational and longstanding authorities to examine, supervise, and regulate banks. Regardless of whether ESG opponents would consider these to be unintended or intended consequences, they would nonetheless have the effect of increasing risks to safety and soundness and financial stability. It would also become more difficult for the government to detect and prevent the financing of illicit activity, enforce fair lending and anti-discrimination protections, and address the growing financial implications of climate change.

So how should policymakers approach this divisive issue? The paper’s third contribution is its conclusion that over-reliance on expansive constitutional arguments, like the First Amendment claims raised in Vullo, would have a detrimental impact on the core functioning of U.S. banking law. As the recent retreat from net-zero banking demonstrates, approaches that are overly deferential to private sector-led efforts to address ESG issues present significant risks of greenwashing. Instead, the paper argues that ESG-related considerations should be treated as policy matters that are resolved through a deliberative federal legislative or rulemaking process pursuant to traditional banking law authorities.

This democratic approach to banking and ESG would help ensure that regulations are consistent with a valid legislative purpose and place appropriate constraints on concentrated private financial power. It would refocus partisan-political debates back into substantive policy choices and lend ESG efforts greater procedural legitimacy. It would also take private banks out of the middle of heated political disputes by establishing rules and norms for the appropriate use of ESG considerations. Ultimately, it would provide a more sustainable path for incorporating ESG considerations into the business of banking.

Graham Steele is an Academic Fellow at the Rock Centre for Corporate Governance at Stanford Law School and a Fellow at the Roosevelt Institute.