A growing number of Republican politicians are moving to penalize Wall Street investors who consider environmental, social and governance (ESG) issues when they decide where to put clients’ money.

In Florida, a state board chaired by Gov. Ron DeSantis recently barred investment fund managers and advisors from considering “social, political, or ideological interests” when making decisions for Florida’s retirement system. In Texas and West Virginia, GOP leaders say they will block investors from state business who they claim “boycott” the fossil fuel industry. Fifteen other states are considering similar measures. And Republicans have said that if they retake Congress in the midterms, they plan to push federal legislation to curtail investment decisions they attack as “woke.”

Anti-ESG Republicans say big financial firms are abusing their power to advance a liberal agenda on issues like diversity, social justice and, especially, climate change.

Many experts disagree, saying Republicans are distorting the goals and strategies of ESG investing.

It’s hard for most people to get a clear read of what ESG is amid the overheated rhetoric. Is the idea to bring about social changes that couldn’t be achieved at the ballot box? And what does it mean for things like your 401K when investors follow ESG principles?

This FAQ is for anyone who wants to better understand an investing trend that is becoming core to global financial markets and a new battlefront in American politics — including, possibly, in your own state.

What is ESG?
It’s probably easiest to think of this as a set of considerations that investors are using to try to understand risks and opportunities that aren’t accounted for in traditional financial models.

Climate change is one of the simplest examples: Investors are trying to find out how physical risks from things like rising sea levels and worsening drought could impact a company’s operations. For example, does a company rely on water to operate its factories, or to move goods in places like Europe or China where rivers have dried to a trickle this summer?

Investors also want information about “transition risk” — how companies will fare as governments enact policies aimed at cutting emissions and demand grows for things like renewable energy and batteries.

“It’s about looking at a business and saying, ‘Are they prepared for the climate transition that’s coming?'” says Witold Henisz, faculty director of the ESG Initiative at The Wharton School of Business at the University of Pennsylvania. “Some companies are, and some companies aren’t. And that tilts your portfolio, it shifts your investment strategy.”

ESG is different from impact investing, where the goal is to make money by investing in companies that are trying to achieve certain social or environmental outcomes.

“In our view, ESG is more of a sort of defensive framework,” says Kunal Shah, a managing director at iCapital, a financial technology company. “Whereas impact investing … is focused on investing in companies with a clear mission to make a change to the positive.”

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