For an illustration of how wildly different the debate around ESG is in Europe and the US, look no further than the German state of Baden-Württemberg.

One of the richest regions in Europe’s biggest economy, and the home of Mercedes-Benz Group AG as well as Robert Bosch GmbH, adopted a law this year that puts investing sustainably on par with more traditional criteria such as profitability and liquidity. It’s a decision that may affect as much as a fifth of the state’s €17 billion ($18 billion) of holdings, as it pivots away from ESG laggards.

Few outside Germany paid much attention to the law when it was passed. But it turns out the legislation has international ramifications. That’s because the new environmental, social and good governance filters have resulted in US Treasuries ending up on an investing blacklist, due to America’s failure to ratify a number of treaties in areas including women’s rights and controversial weapons. Other nations to be singled out by the policy include Finland, Latvia and Greece.

The bulk of Baden-Württemberg’s exclusions impact its equity and corporate portfolios. The law establishes the United Nations Sustainable Development Goals, the European Union’s Taxonomy Regulation and the Paris Agreement on climate change as the basis for future investment decisions. bond

The practical investment implications of the law are limited when it comes to US Treasuries, because the German state’s holdings weren’t significant to start with. In fact, German holdings of US Treasuries overall account for a tiny fraction of the market, or just $85 billion of the $24 trillion in outstanding debt, according to the latest data. And there’s little to indicate that investors’ ESG considerations in general have left any kind of dent on the US Treasury market.

Relying on international treaties to determine portfolio exclusion lists is “kind of a blunt approach,” Arnim Emrich, head of Baden-Württemberg’s treasury and asset management unit, said in an interview. “But it’s the only proxy we have that is simple and objective.”

In many ways, the investment approach is the polar opposite of a framework that Republican-led states are currently trying to create in the US. ESG principles have been vilified by senior members of the GOP, including presidential candidate Ron DeSantis, who wants to eradicate ESG and the “woke ideology” he says it represents. In the US, banks and financial firms are now quietly burying their use of the acronym, and more than a dozen US state governors want to prohibit the use of ESG in all investment decisions.

“The gap between EU and US policymakers continues to widen,” said Maia Godemer, a sustainable finance researcher at BloombergNEF. “EU policymakers are now convinced that ESG risks are financially material, while in the US such a premise is still vividly debated. In fact, some US policymakers see ESG investment strategies only as a way to push forward a liberal political agenda.”

The Biden Labor Department is currently fighting a challenge brought by more than two dozen Republican state attorneys general that would prevent pension plans from incorporating ESG considerations into their investment decisions. The GOP AGs and the DOL are now awaiting a decision from the US District Court for the Northern District of Texas.

That’s amid growing evidence pointing to the ability of ESG screens to deliver better returns over time, when adjusting for risk.

Back in Germany, meanwhile, other states have taken similar steps. Baden-Württemberg, the only one of Germany’s 16 states with a coalition government led by the Greens,  was inspired by a similar law in the smaller state of Schleswig-Holstein, where bans apply to US Treasuries as well as to fossil-fuel companies. And the pension funds of Brandenburg, Hesse and Germany’s richest state North Rhine-Westphalia are this year allocating as much as €11 billion to Paris-aligned stock indexes that exclude ESG laggards alongside Baden-Württemberg.

“We are showing how sustainable investments are possible and that the public sector can and should be a role model and driving force here,” Michael Boddenberg, minister of finance in Hesse, said in a statement announcing the move.

Andreas Hoepner, a professor at University College Dublin’s Smurfit Graduate Business School, said one reason ESG is less politicized in Europe might relate to countries’ voting systems, which generally encourage coalitions and consensus-building. That’s in contrast to the two-party system that shapes US politics, he said.

For Baden-Württemberg’s Emrich, the less polarized environment allows politicians to have technical discussions on specific aspects of ESG, such as whether genetically-modified crops are a sustainable investment.

“We don’t have the clear-cut for-and-against on ESG investing yet in Germany,” he said. “Hopefully we will never have it, because you should rather have a debate about the different issues within ESG.”

--With assistance from Iain Rogers.

This article was provided by Bloomberg News.