US legal developments targeting ESG: implications for the financial industry

September 2025 | SPOTLIGHT | RISK MANAGEMENT

Financier Worldwide Magazine

September 2025 Issue

Over the past decades, environmental, social and governance (ESG), a term that generally refers to a broad set of criteria related to these topics, which are used to measure a company’s performance, has been increasingly adopted by the financial sector.

This trend grew out of United Nations-led initiatives (such as the Principles for Responsible Investment), which led to industry-led voluntary disclosure frameworks (such as the Task Force on Climate-related Financial Disclosure recommendations) and, most recently, legal mandates such as the European Union’s (EU’s) Sustainable Finance Reporting Directive.

Financial institutions (FIs) have incorporated ESG into their operations in a variety of ways: assessing climate change risks on asset portfolios, applying ESG metrics to investment and lending decisions, and structuring and marketing ESG-aligned financial products for investors.

However, in recent years, ESG has emerged as a partisan political issue and has met headwinds, leading policymakers and industry participants to question whether the adoption of ESG by FIs is appropriate and consistent with the goal of maximising value for shareholders and fund beneficiaries.

In state legislatures across the US, dozens of statutes have been enacted targeting ESG while state attorneys general and other regulators have investigated or sued FIs for their ESG practices. Efforts at federal level have followed as well.

State law restrictions on ESG

Since 2021, approximately 18 states have passed laws of various types intended to restrict or discourage the use of ESG considerations by FIs (as well as other companies) in a number of ways.

These laws broadly fall into three categories, as outlined below.

Investment standards for public funds. These laws regulate how state and local public funds, such as public employee pension plans, consider ESG in managing investments by restricting the use of so-called ‘nonpecuniary’ factors. Some of these laws (such as Florida’s HB 3) explicitly provide that ESG factors are nonpecuniary. Others acknowledge that ESG factors may be considered if they impact financial returns, such as Arkansas’s law, which allows the consideration of ESG factors that a “qualified investment professional would treat as a material economic consideration under generally accepted investment theories”.

Some state laws have taken the opposite approach to ESG. For example, New Hampshire has a law allowing the consideration of ESG factors in investing state funds, while states like Illinois and Maryland mandate it. Other states, such as Oregon, have laws that explicitly require state funds to divest from certain industries, such as coal.

‘Anti-boycott’ laws. These laws prohibit the government from engaging with financial firms that restrict their investment activities (called a ‘boycott’ under many of these laws) with certain industries – such as fossil fuels or firearms – or with companies that lack policies aligned with ESG-related priorities, such as greenhouse gas emissions reduction targets.

Some laws also prohibit the government from granting contracts above a certain value to businesses outside the financial sector that engage in so-called boycotting behaviour. Unlike the laws restricting ESG-based investing, these laws apply whether or not the activities deemed to be a boycott relate in any way to services provided to a governmental agency.

Many of these laws require the state to maintain a registry of barred companies or require companies to certify that they do not engage in ‘boycotting’ behaviour. In practice, several states have applied these restrictions to financial services firms that have net-zero goals or policies that prohibit financing fossil fuel industries.

Nearly all of these laws provide that conduct taken with an “ordinary business purpose” (not always defined in the statutes) is not considered a boycott. However, in practice, some states (such as Arkansas and Texas) have rejected these arguments.

Restrictions on ESG considerations in the private sector. A smaller number of states have passed laws prohibiting companies (mainly in the financial sector) from using ESG criteria to determine whether and under what conditions to provide services to customers. Unlike the other two categories, these laws – often referred to as ‘fair access’ laws – apply to private sector business operations unrelated to government contracting or investments.

These laws vary widely in scope. Florida’s HB 3 is relatively broad in the scope of the businesses covered (banks and other lenders and personal finance companies), the range of regulated activities (any “services”) and the breadth of the prohibition (e.g., discrimination on the basis of a customer’s “social credit score”, a term which covers a broad range of ESG-related considerations).

In contrast, Texas’s SB 833 targets insurers and prohibits providing less favourable terms based on ESG factors, subject to an exception for “ordinary insurance business purpose”. Other laws are even narrower, focused on discrimination based on a customer’s engagement in specific industries, such as firearms.

In 2024, the Office of the Comptroller of the Currency (OCC) expressed the view that certain of these laws may be preempted by federal banking regulation. However, the Trump administration is not expected to maintain this view and may instead pursue rulemaking similar to a rule issued (but not formally adopted) by the OCC near the end of the first Trump administration that paralleled these state laws by requiring certain banks to issue services based on “quantitative, impartial, risk-based standards”.

State anti-ESG enforcement proceedings

States have initiated investigations or legal proceedings targeting the financial sector asserting that their use of ESG is anti-competitive or deceptive to consumers. Perhaps the most prominent of these efforts is a federal lawsuit brought in November 2024 by 11 states against several large asset managers, alleging (among other things) that their climate policies led them to illegally collude to use their investments in coal companies to constrain the supply of coal, thereby driving up electricity prices. States have also brought legal proceedings alleging that certain ESG practices constitute violations of consumer protection laws.

Federal government efforts targeting ESG

The Trump administration has mainly focused on halting or rolling back ESG initiatives launched during the Biden administration, including abandoning the legal defence of the Securities and Exchange Commission’s (SEC’s) rules on disclosure of climate-related risks, withdrawing proposed SEC rules regarding disclosures for ESG-focused funds and rolling back the Department of Labor’s rule allowing the consideration of ESG factors by fiduciaries managing retirement plans regulated by the Employee Retirement Income Security Act of 1974.

Beyond these actions, the contours of the administration’s response to ESG continues to take shape. In February 2025, the SEC issued guidance that has the effect of limiting shareholders’ ability to advocate for ESG policies by strengthening companies’ authority to exclude shareholder proposals from their proxy statements and increasing disclosure requirements for certain kinds of shareholder engagement.

More recently, the federal government joined the November 2024 lawsuit brought by 11 states against asset managers. And in April 2025, President Trump issued an executive order directing the attorney general to take action to stop enforcement of state laws relating to ESG (and related areas) determined to be illegal.

The status of these efforts is unclear. The executive order requires the attorney general to report on its activities within 60 days of the order, yet no such order has been made public to date.

Industry reaction

There has been a perceptible retreat from ESG commitments within the financial sector, a shift that many observers attribute, at least in part, to recent legal and political developments.

In 2025, several major FIs withdrew from two prominent initiatives – the Net-Zero Banking Alliance and Net Zero Asset Managers – both of which require participants to align their operations with the goal of achieving net-zero greenhouse gas emissions by 2050. The latter initiative has since suspended its activities.

This trend was already evident by the end of 2024, when more than 70 investment and financial firms had exited Climate Action 100+, an investor-led coalition aimed at encouraging large greenhouse gas emitters to take meaningful climate action. Further underscoring this shift, four global banks in 2025 either delayed or entirely abandoned their net-zero goals or sustainable finance targets.

Key takeaways

A financial firm’s strategy for navigating conflicting ESG trends will depend on the legal frameworks relevant to its geographic and operational footprint as well as the priorities and interests of its customers, investors and other stakeholders. This will require companies to consider the alignment of their ESG policies and practices with applicable legislation in each relevant jurisdiction. That said, outlined below are broad guidelines that firms with potential exposure to these legal developments should consider.

First, focus ESG policies on value creation, risk mitigation and client service. FIs with potential exposure to these trends should consider linking their ESG-related commitments and targets to creating value, managing climate risk and servicing client preferences rather than to furthering societal goals such as decarbonisation or diversity, equity and inclusion. In addition, emphasising the ‘business case’ of ESG policies can help demonstrate that they meet the ‘ordinary business’ or ‘pecuniary’ purpose standards under many of the laws discussed above, although as noted, some state officials have resisted these arguments.

Second, consider antitrust implications of industry ESG initiatives. Industry alliances such as Climate Action 100+ and various net-zero initiatives have been the focus of state antitrust investigations and lawsuits. FIs should consider the risks of joining such alliances, particularly if they could have anti-competitive impacts.

Third, consider ‘greenwashing’ and ‘greenhushing’ risk in public disclosures. A common area of focus of lawmakers and regulators – regardless of their approach to ESG – has been the accuracy of companies’ public statements pertaining to ESG. This includes ‘greenwashing’, making deceptive or unsupported claims regarding a company’s activities relating to climate change or other ESG matters and ‘greenhushing’, the practice of concealing or downplaying a company’s ESG policies.

Companies should ensure that all public disclosures relating to ESG matters, including regulatory filings, voluntary ESG reporting, and marketing and investor communications, are aligned and that a process is in place to ensure compliance with applicable regulations.

Fourth, tailor product offerings accordingly. FIs can tailor investment vehicles targeting prospective investors subject to anti-ESG state laws by, for example, explicitly disclaiming or limiting consideration of ESG factors in the relevant investment fund documents, while at the same time incorporating ESG into funds marketed to investors that favour ESG (e.g., pension funds in states with pro-ESG laws). Such offerings should be consistent with firm-wide ESG policies.

Lastly, consider laws in other jurisdictions. ESG laws in states such as California and New York or in foreign jurisdictions such as the EU may be at odds with the state laws discussed above. Financial firms subject to these laws need to consider their impact as well.

Loyti Cheng and David Zilberberg are counsels at Davis Polk. Ms Cheng can be contacted on +1 (212) 450 4022 or by email: loyti.cheng@davispolk.com. Mr Zilberberg can be contacted on +1 (212) 450 4688 or by email: david.zilberberg@davispolk.com.

Loyti Cheng and David Zilberberg

Davis Polk