Introduction
Environmental, social, and governance (ESG) integration has become a defining feature of modern banking and finance, evolving from a peripheral corporate social responsibility initiative into a core strategic imperative. Yet the current landscape reveals a financial sector caught between competing forces: institutional investors managing $33.8 trillion in assets who remain committed to sustainability criteria, and a growing wave of state-level restrictions that challenge the legitimacy of ESG considerations in investment decisions. This article examines how financial institutions operationalize ESG principles and navigate the increasingly polarized regulatory environment shaped by state-level legislation.
How Financial Institutions Integrate ESG
Strategic Framework and Risk Management
Financial institutions have embedded ESG factors across multiple operational dimensions, moving beyond compliance toward strategic value creation. Many banks now evaluate potential investments and lending opportunities through an ESG lens, assessing not only traditional financial metrics but also environmental impact, social contributions, and governance quality.
Integrating ESG into risk management frameworks marks a fundamental shift in how banks assess exposure. Environmental risks, such as climate change, can significantly affect loan portfolios, particularly for institutions with exposure to carbon-intensive industries. Physical risks from extreme weather events threaten asset quality, while transition risks tied to decarbonization policies create long-term financial implications. Social and governance risks, including human rights violations or corruption scandals, can similarly destabilize financial institutions.
Leading banks have established mechanisms to track the carbon intensity of their financed portfolios, recognizing that Scope 3 financed emissions are the largest contributor to banking sector emissions. These institutions support clients on transition journeys while aligning the carbon intensity of their loan portfolios with science-based pathways. The European Banking Authority published final guidelines on ESG risk management[1] on Jan 9, 2025, requiring financial institutions to identify, measure, manage, and monitor ESG risks through structured transition plans that ensure resilience across short-, medium-, and long-term horizons.
Product Development and Innovation
Financial institutions have developed sophisticated ESG-aligned product offerings to meet evolving investor demand. These offerings include:
- Green bonds and sustainability-linked loans: Financing instruments tied to environmental objectives, with banks requiring borrowers to meet defined sustainability performance targets.
- ESG investment funds: Portfolios screening companies based on environmental, social, and governance criteria, with funds allocating at least 80% of investments to qualifying objectives under European Securities and Markets Authority guidelines, effective May 2025.
- Thematic investing: Moving beyond generalist ESG approaches toward targeted strategies focused on specific impact areas, such as renewable energy, gender equality, or biodiversity.
According to BNP Paribas’ ESG Survey 2025,[2] which gathered responses from 420 institutional investors across 29 countries, representing $33.8 trillion in assets under management, 85% of respondents integrate sustainability criteria into investment decisions, and 59% engage in thematic investing. The top sustainability objectives for the next two years are increasing allocations to energy-transition assets (49%) and using active ownership to advance ESG goals (47%).
Data Infrastructure and Technology
Robust ESG data collection, verification, and reporting systems have become essential infrastructure. Major institutions have implemented centralized ESG data platforms that consolidate information from dozens of internal and external sources. Banks increasingly use artificial intelligence (AI) and advanced analytics to monitor performance, assess risks, and generate actionable insights.
However, data challenges persist. According to a prominent ESG Risk Survey,[3] many institutions struggle with inconsistent data collection and a lack of standardized ESG metrics. Limited historical data and the complexity of measuring Scope 3 emissions remain key obstacles to integrating ESG into core risk management frameworks.
Governance and Accountability
Leading banks have restructured governance to embed ESG accountability. This includes linking executive compensation to sustainability targets, improving board diversity, and enhancing disclosure. BNP Paribas integrated ESG key performance indicators into its 2025 strategic plan, setting quantifiable targets across all business divisions. Nordea tied 30% of executive variable compensation to ESG outcomes, exemplifying the shift toward measurable accountability.[2]
The Polarized U.S. Regulatory Environment
Anti-ESG Legislation in Republican-Led States
As of last year, approximately 19 states have enacted laws[4] that restrict ESG considerations in various forms. These states include Alabama, Arkansas, Florida, Georgia, Idaho, Indiana, Kansas, Kentucky, Louisiana, Montana, North Carolina, North Dakota, Ohio, South Carolina, Tennessee, Texas, Utah, West Virginia, and Wyoming.
These restrictions fall into several categories:
Investment Restrictions: Laws that prohibit public pension funds and state investment managers from considering ESG factors unless based on pecuniary financial considerations. For example, Ohio’s HB 96 (2025)[5] stipulates that investment decisions cannot have the “primary purpose” of furthering ESG or other “personal” or “ideological” policies. However, the statute does not define “primary purpose.”
Anti-Boycott Provisions: Restrictions that prevent state entities from contracting with financial institutions deemed to “boycott” or “discriminate” against specific industries, particularly fossil fuels, firearms, and mining. These laws often establish blocklists of sanctioned companies.
Proxy Voting Restrictions:Texas Senate Bill 2337,[6] signed into law in June 2025, narrows shareholder participation in pivotal ESG-related matters for firms incorporated or headquartered in the state. The law requires proxy advisors to label certain recommendations as “not provided solely in the financial interest of shareholders” and expressly defines ESG incorporation and sustainability scoring as “non-financial.”
Disclosure Mandates: Some states require extensive disclosure when ESG factors influence investment decisions, creating compliance burdens that discourage ESG integration.
The practical impact of these laws has been substantial. Research indicates that anti-ESG laws in Texas have imposed economic costs, with restrictions leading to higher borrowing costs for municipalities and lower investment returns for public pension funds. A 2024 United Nations-backed Principles for Responsible Investment report concluded that anti-ESG efforts could have “significant unintended consequences” and “fail to achieve their goals.”[7]
Enforcement Actions and Litigation
Republican state attorney generals have escalated enforcement beyond the scope of legislation. In 2025, Florida’s Attorney General announced an investigation into whether the Climate Disclosure Project (CDP) and the Science Based Targets Initiative violated state consumer protection or antitrust laws by coercing companies into disclosing proprietary data.[8] The investigation examines whether coordination among CDP, financial institutions, and investment services constitutes unlawful market manipulation.
On July 29, 2025, treasurers and financial officers from 21 states sent letters to major investment firms warning against embedding ESG considerations into investment strategies and urging firms to “reaffirm and operationalize their commitment to traditional fiduciary duty.” Missouri’s attorney general launched investigations into proxy advisory firms, alleging that they advanced “radical ESG and DEI priorities” that violated fiduciary duties.[9]
In late 2024, Texas and 10 other Republican-led state attorneys general sued three large financial services firms for allegedly violating antitrust laws through ESG collaborations, which they characterized as forming an anticompetitive “climate cartel.”[10]
Pro-ESG States and Disclosure Requirements
In contrast, several Democratic-led states have enacted legislation that promotes or mandates ESG considerations. States with rules more favorable to ESG investing include California, Colorado, Illinois, Maine, and Maryland. Additionally, Illinois and New Hampshire have implemented ESG disclosure rules.
California’s approach has been particularly comprehensive. Senate Bills 253[11] and 261[12] established detailed climate disclosure requirements, mandating that companies earning more than $1 billion annually report Scope 1 and 2 emissions by 2026, with Scope 3 emissions to follow in 2027. Companies with annual earnings above $500 million must submit climate-related financial risk reports by 2026. The California Air Resources Board received an extension until July 2025 to develop implementation rules. Given California’s economic significance, these requirements effectively serve as the national standard for climate disclosure.
Federal Regulatory Retreat
The federal landscape has shifted dramatically with the change in presidential administrations. The Securities and Exchange Commission (SEC) formally withdrew its proposed climate disclosure rules in March 2025 and, in June 2025, withdrew its proposed ESG disclosure requirements for investment advisers and funds. The Department of Labor (DOL) has indicated plans to amend regulations that would permit Employee Retirement Income Security Act (ERISA) fiduciaries to consider ESG factors, reverting to prior restrictions.
This federal retreat has intensified the patchwork of state regulations, creating significant compliance challenges for multi-state financial institutions that must navigate both California’s comprehensive disclosure mandates and Texas’s restrictions on ESG considerations.
Industry Response and Market Adaptation
Coalition Exits and ‘Greenhushing’
In response to political and legal pressures, major financial institutions have reassessed their participation in climate coalitions. Since December 2024, six major U.S. banks, including JPMorgan, Citigroup, Bank of America, Morgan Stanley, Wells Fargo, and Goldman Sachs, have withdrawn from the UN-sponsored Net Zero Banking Alliance.[13] Analysts attribute these departures to efforts to avoid “anti-woke” attacks by officials in the new political environment.
However, experts note that these withdrawals reflect strategic shifts in communication rather than substantive changes in sustainability practices. Banks continue to embed climate risk considerations into lending decisions and investment portfolios, driven by financial materiality rather than coalition membership.
The phenomenon of “greenhushing,” the practice of underreporting or concealing ESG activities to avoid scrutiny, has emerged as institutions fear public and legal backlash. Some 41% of respondents in the BNP Paribas survey suggest adopting a more reserved approach to communicating ESG processes and achievements, reflecting the silencing effects of a polarized environment.[2]
Continued Institutional Commitment
Despite political headwinds, institutional investor commitment to ESG integration remains strong. The BNP Paribas survey found that 87% of respondents said their ESG and sustainability objectives remain unchanged, and 84% believed the pace of sustainability progress would continue or accelerate through 2030.[2]
ESG fund assets under management are projected to exceed $33.9 trillion globally by 2026, reflecting sustained growth in retail and institutional investor interest. Data from the first half of 2025 show that sustainable funds generated a median return on investment of 12.5%, outperforming traditional funds at 9.2%, underscoring that ESG integration can be a value driver rather than merely an ethical consideration.
Private capital managers have deepened their ESG engagement, recognizing opportunities tied to the transition to a low-carbon economy. These managers can serve as powerful agents of change through hands-on approaches in real estate and infrastructure, directly reducing carbon emissions and enhancing biodiversity.
Legislative Momentum Shifts
Notably, the pace of anti-ESG legislation has slowed considerably. According to a July 2025 Pleiades Strategy report,[14] 106 anti-ESG bills were introduced in state legislatures. Still, only 11 passed, a low success rate that reflects states’ experience with the financial costs of prior-year restrictions. Even the laws that passed were often “watered down or equipped with escape clauses that weaken their impact.”
Arkansas House Bill 1507, which prohibits state universities and government institutions from considering ESG or diversity, equity, and inclusion (DEI) in investment decisions, includes an exception when restrictions would have a “materially financial impact,” underscoring the practical recognition that rigid anti-ESG mandates can harm financial performance.
European Contrast and Global Divergence
While the U.S. experiences regulatory fragmentation, Europe has maintained its commitment to ESG disclosure and sustainability requirements, though with some simplification measures. The European Union’s (EU’s) Corporate Sustainability Reporting Directive expansion in 2025 marks a critical milestone, requiring even previously exempt entities to report on sustainability matters.
The European Commission approved a new ESG ratings regulation aimed at making rating activities more consistent, transparent, and comparable, boosting investor confidence in sustainable financial products. Europe accounts for 84% of global sustainable fund assets, and European asset owners have put American fund managers who withdrew from climate alliances on notice, with some withdrawing assets from firms such as State Street to prioritize sustainability and active stewardship.
The European Banking Authority’s January 2025 guidelines require banks to integrate ESG risks into governance, risk management, and supervision, harmonizing practices across Europe to prevent institutions from falling behind in structural ESG integration.[15] France’s Article 29 of the Energy-Climate Law requires French financial institutions to publish annual reports detailing how they account for climate and biodiversity risks in investment strategies.[16]
Implications for Financial Institutions
Strategic Considerations
Financial institutions operating in the U.S. face unprecedented complexity in balancing competing regulatory demands, stakeholder expectations, and fiduciary duties. Several strategic imperatives are emerging:
Regional Compliance Strategies: Multistate institutions must develop sophisticated compliance frameworks that accommodate both California’s comprehensive disclosure requirements and Texas’s restrictions on ESG considerations. Legal teams must comply with one state’s emissions guidelines without violating another state’s rules that protect the fossil fuel industry.
Communication Calibration: Institutions must carefully calibrate external communications on sustainability practices. While maintaining substantive ESG integration driven by risk management and investor demand, public messaging may become more measured to avoid political targeting.
Fiduciary Defense: Banks must articulate how ESG considerations align with fiduciary duties by demonstrating the financial materiality of environmental and social factors. This includes documenting how climate risk, social license to operate, and governance quality affect long-term value creation and risk mitigation.
Data Infrastructure Investment: Nearly half of investors (48%) in the BNP Paribas survey anticipate allocating more budget to ESG data acquisition and analysis to ensure reliable data. Centralized digital tools and AI-driven software can automate data aggregation, improve accuracy, and provide real-time regulatory risk insights.
Opportunities in Transition
Despite political polarization, the transition to sustainable finance presents substantial opportunities. Development finance institutions provide first-loss capital, guarantees, and technical assistance to make ESG-oriented projects more attractive to commercial investors. The blended finance model[17] aims to mobilize portions of the $100 trillion in unused private and institutional capital seeking annual returns, with approximately $3.9 trillion required annually to achieve the Sustainable Development Goals.
Increasing investor preference for sustainable and ethical investments, particularly among Gen Z and millennial investors, is driving demand for ESG-aligned financial products. According to Morgan Stanley research, more than 85% of individual investors and nearly 95% of millennials report interest in sustainable investing.
Long-Term Outlook
The regulatory landscape will likely remain fragmented in the near term, with state-level divergence persisting in the absence of federal standardization. However, financial institutions that successfully navigate this complexity by embedding ESG into core business strategies while maintaining regulatory compliance across jurisdictions will likely gain a competitive advantage.
Banks that treat ESG as both a risk-management necessity and a value-creation opportunity, rather than merely a compliance obligation, demonstrate stronger financial performance and greater resilience. Research from UNEP FI and the MSCI Institute’s November 2025 analysis shows that banks that embed sustainability into core business outperform peers on both ESG and financial indicators, with enhanced sustainability leadership lowering capital costs, expanding market access, and strengthening resilience.
Conclusion
ESG integration in financial institutions has evolved from a voluntary, values-driven approach to a strategic imperative driven by investor demand, regulatory requirements, and risk management needs. However, the current landscape reveals deep regulatory fragmentation, with approximately 19 U.S. states restricting ESG considerations, while others mandate enhanced disclosure, and Europe maintaining comprehensive sustainability frameworks.
Financial institutions must navigate this polarized environment by maintaining substantive ESG integration grounded in financial materiality and carefully calibrating communications and compliance strategies to regional regulatory requirements. Institutions that successfully balance these competing demands by embedding sustainability into risk management, governance, and strategy, and by demonstrating fiduciary alignment, will likely emerge as leaders in an increasingly sustainability-focused global economy.
The fundamental question is no longer whether ESG factors matter for financial performance and risk management, but how financial institutions can operationalize these considerations in a fractured, politicized regulatory landscape. As data continue to show that sustainable banking practices contribute to superior long-term financial outcomes, market forces may ultimately transcend political divisions, driving continued ESG integration despite regulatory variability.
References
[1] https://www.greenscope.io/en/esg/bank
[2] https://securities.cib.bnpparibas/esg-survey-2025/
[3] https://www.globalbankingandfinance.com/embedding-esg-in-banking-risk-regulation-and-the-road-ahead/
[4] https://www.morganlewis.com/pubs/2025/05/esg-investing-update-trends-in-legislation-litigation-and-market-response
[5] https://search-prod.lis.state.oh.us/api/v2/general_assembly_136/legislation/hb96/07_EN/pdf/
[6] https://capitol.texas.gov/tlodocs/89R/billtext/html/SB02337F.HTM
[7] https://www.unpri.org
[8] https://www.myfloridalegal.com/newsrelease/attorney-general-james-uthmeier-launches-investigation-climate-cartel-potential
[9] https://sfof.com/wp-content/uploads/2025/07/Fiduciary-Duty-Letter-to-Asset-Managers_BLACKROCK.pdf
[10] https://www.texasattorneygeneral.gov/news/releases/attorney-general-ken-paxton-sues-blackrock-state-street-and-vanguard-illegally-conspiring-manipulate
[11] https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=202320240SB253
[12] https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=202320240SB261
[13] https://www.unepfi.org/net-zero-banking/
[14] https://static1.squarespace.com/static/60c10f47894447090b1b6567/t/6862f47af380d07ac8a94eb0/1751315578927/2025_Statehouse_Report.pdf
[15] https://www.eba.europa.eu/activities/single-rulebook/regulatory-activities/sustainable-finance/guidelines-management-esg-risks
[16] https://www.amf-france.org/en/news-publications/news/reporting-under-article-29-energy-climate-law-amf-updates-its-policy-how-prepare-and-submit-reports
[17] https://www.fortunebusinessinsights.com/esg-investing-market-113824
© Copyright 2026. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.
