Pro-ESG Vermont fights fossil fuel divestment bill

The Vermont Pension Investment Commission, the overseer of Vermont's three largest pension funds, is fighting to beat back a bill that would require it to divest any holdings in fossil fuel companies — and so far its efforts appear to be working.

After airing its concerns during public meetings in February and March, VPIC managed to persuade lawmakers in the Senate to consider a compromise, one that VPIC views as the best way to get companies to address climate change without jeopardizing the pension benefits of current and future retirees.

The compromise calls for a legislative amendment that would exclude index funds and private equity investments from having to be carbon-free. VPIC argued that these exclusions would help maintain the low cost and stability of the state's pension funds for teachers, municipal workers and state employees.

"I think you really need to exclude index funds from the mix because it would put Vermont at a significant disadvantage if we weren't able to access traditional indexing products," said VPIC Chairman Thomas Golonka during his testimony in February.

Mr. Golonka explained that carbon-free index funds are "twice the price" of traditional, broad-based index funds and have more volatility.

Mr. Golonka also pleaded with lawmakers to exclude private equity investments from the divestment requirement, saying that such investments are key to hitting VPIC's assumed rate of return for the three pension plans that make up the $5.5 billion Vermont State Retirement Systems — Vermont State Employees' Retirement System, the State Teachers' Retirement System and the Municipal Employees' Retirement System.

If VPIC were forced to lower its assumed rate of return because it could not invest in private equity, it would put its pension plans in significant jeopardy, he said. Mr. Golonka explained that ESG restrictions on private equity would prevent VPIC from getting into long-term contracts with "top-tier" private equity managers.

"You don't want to be in private equity unless you feel you can be at the top tier," he said. "There's no reason tying up your money if you can't do that."

Mr. Golonka and other VPIC members also reminded lawmakers of VPIC's strong track record in working with companies to enhance their environmental, social and governance practices through proxy resolutions, an approach they argued was more effective than divesting.

Simply selling the shares of carbon-intensive companies would only put them in the hands of a less responsible shareholder unlikely to apply the kind of pressure that VPIC applies on fossil fuel companies to adopt friendlier environmental practices, said Eric Henry, VPIC's chief investment officer.

Less responsible shareholders are not "going to go head-to-head with the board of directors of an energy company" nor are they going to "not back off until they show clear metrics and clear plans for reducing their emissions," he said.

Throughout his presentation, Mr. Golonka maintained a deferential tone, continually reminding lawmakers that VPIC saw itself as a partner in their pursuit of a cleaner environment.

The approach appears to have worked. During a public meeting on March 3, lawmakers circulated a draft amendment to the bill that would exclude index funds and private equity funds from having to divest from carbon-intensive companies. The amended bill would also require that VPIC's direct holdings apart from private equity have no more than a 2% "de minimis" exposure to fossil fuels.

Of the $5.5 billion in the Vermont State Retirement Systems, roughly $3 billion to $4 billion is in index funds and $1 billion is in direct holdings, Mr. Golonka said during his testimony.

What the Senate bill will ultimately look like is anyone's guess. The legislation is a work in progress that won't be finalized or voted on until mid-March at which time it would move to the House, said Democratic state Sen. Alison Clarkson, one of the co-sponsors of the bill.

Similar discussions are playing out in other states, with the outcome for state pension fund officials hanging in the balance. In Oregon, for example, a fight over a fossil fuel divestment bill is also heating up. Among other things, the bill prohibits the state treasurer from making new carbon-intensive investments and orders the treasurer to divest funds invested in companies on the Carbon Underground 200 list, a compilation of the top 100 coal and 100 oil and gas publicly traded reserve holders globally.

"Statutorily limiting the investment opportunities of the Oregon Public Employee Retirement System — no matter how well-intentioned — will lead to lower returns, higher employer rates and a less robust retirement for thousands of Oregonians," Oregon Treasurer Tobias Read wrote in a letter to state lawmakers.

California also introduced a package of bills in January in the Senate that would require the state's largest pension funds – the $457.4 billion California Public Employees' Retirement System and the $311.5 billion California State Teachers' Retirement System – to divest from fossil fuels.

In testifying before legislators, VPIC appealed to both the head and the heart, looking at the cost of divestment on state pension funds as well as the merits of engaging with, rather than divesting from, carbon-intensive companies.

VPIC's Mr. Golonka noted that the commission pays 2 basis points for its index funds, a "significant cost savings." If the commission were forced to do "personalized indexing," it would need to hire more people, which would drive up costs even more.

Mr. Golonka also presented numbers to show the impact of having to divest from private equity holdings, which he said outperformed the comparable index by 1,000 basis points and was used to set VPIC's actuarial rate of return.

If VPIC had to lower the rate of return to 6.5%, for example, from the current 7% it would lead to a $50 million increase in the actuarially determined employer contribution, the amount the state would have to put into the retirement system annually.

"By 2038, it's a $750 million increase in payments that would have to be made both through the employer and employee contributions," Mr. Golonka said.

Mr. Henry made similar arguments about the impact of divestment on the health of the state's pension system.

"This needs to be about having the right level of pension benefits in place to attract and retain a qualified workforce but at a level of cost that's reasonable and sustainable to the taxpayers," Mr. Henry said.

Mr. Henry also argued that divestment is ineffective. "Empirical studies have continued to show that divesting of these companies simply does not work," he said. "It does not change their behavior. It does not improve their behavior. It does not reduce carbon emissions."

In Mr. Henry's view, a better approach is to engage companies through the shareholder proxy process. "Study after study continues to show that engaging with these companies through proxy votes can and does incentivize them to be better citizens," he told lawmakers.

Mr. Henry cited the example of a large energy company that was flaring a lot of excess methane in the Bakken region. Through a proxy initiative, VPIC was able to get the company to commit to setting specific goals for their management team to reduce the flaring. Importantly, the company incorporated those metrics into the company's management compensation plans, a move that resulted in VPIC removing the proxy from the ballot.

Directly linking executive compensation to climate change goals is considered best practice, said Katie Green, VPIC's deputy CIO.

VPIC declined to disclose the company because the commission is continuing to engage the company on other matters, Ms. Green said.

Ms. Green, who has been instrumental in VPIC's engagement and proxy-voting initiatives, endeared lawmakers to VPIC's point of view when she talked about how the commission enjoyed being the "squeaky wheel," the badger relentlessly pushing companies to do more on improving their environmental processes.

With an amended bill, VPIC would be able to both hold less than 2% in fossil fuel companies while continuing to engage those shares, Ms. Green said.

"We don't want to stop our work," Ms. Green implored lawmakers. "I think it would be a detriment to the world if we weren't the squeaky wheel."