Department of Labor Limits Consideration of ESG Factors in Pension Plan Investing
By: Katherine Pino, RBFL Student Editor
The Department of Labor recently fast-tracked a controversial rule that would make changes to the Employment Retirement Income Security Act of 1974 (ERISA) limiting plan fiduciaries’ ability to incorporate environmental, social, and governance (ESG) factors into their investment decisions. Proposed on June 23, 2020, the rule was finalized by the White House on October 30, 2020.
This new rule, named “Financial Factors in Selecting Plan Investments,” has been pushed through to finalization at an unusually fast pace. After proposing this rule, the DOL only allotted a 30-day public comment period. Rules like this are usually given a 60- to 180-day public comment period and take around eighteen months to become finalized. This rule was submitted for finalization to the White House in less than four and a half months, despite widespread opposition and complaints.
Under this new rule, employee pension plan fiduciaries will only be able to make investment decisions based solely on “financial considerations relevant to the risk-adjusted economic value” of the particular investment. While it is a long-standing position of the DOL to put the economic interests of pension plan participants before other considerations, this rule severely limits plan fiduciaries’ ability to consider financially material ESG factors into their investment decisions. It is the DOL’s opinion that “[i]t does not ineluctably follow from the fact that an investment promotes ESG factors. . . that the investment is a prudent choice for retirement or other investors.” The rule has cemented these guidelines into law, unusual in an area where DOL guidance tends to change with each administration.
Concern for sustainable investing and ESG among corporations and shareholders is at an all-time high. This sentiment is evident in the over 8,700 public comments that were submitted in response to this rule, over 94% in opposition to the changes. Prominent institutional investors such as BlackRock and Vanguard wrote lengthy comments opposing the rule and urged the DOL to reconsider. In their comment detailing the financial benefits of ESG investing, BlackRock “encourage[d] the DOL to engage with plan sponsors, investment managers, and index providers to understand how ERISA plans can . . . incorporate ESG factors to drive positive economic outcomes for plan participants.”
The language in this DOL regulation shows that the government does not place economic value on sustainable investing decisions. Instead, the rule forces plan fiduciaries to focus only on the traditional indicators of financial performance in an investment. Secretary of Labor Eugene Scalia, commenting on this new rule, stated that “[p]rivate employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan.”
This thinking is at odds with proponents of ESG, who maintain that sustainable investing has inherent economic value. Market performance indicators show that ESG portfolios are often out-performing traditional portfolios. In 2019, a typical ESG portfolio outperformed the S&P index by 45%. Studies have found that investors who screened for ESG considerations could have avoided 90% of S&P 500 bankruptcies from 2005 to 2015. In addition, traditional financial indicators are no longer the only measurement of an investment’s success. In the fiscal year 2018, 68% of companies’ total value was attributed to intangible assets like brand reputation. Given the growing shift towards sustainability practices, a company’s intangible assets can be significantly bolstered by incorporating ESG considerations into their operations.
“Financial Factors in Selecting Plan Investments” displays the disconnect between the DOL and the movement of industry actors towards ESG investing. Rules like this, especially when they are codified into law and no longer serve only as a guideline, severely impact the ability of large investors like pension plans to consider ESG factors. This in turn could limit the effort to mainstream ESG considerations in investing and serve as a significant barrier for the industry’s movement towards sustainability.
Sources:
BofA Securities, 10 Reasons to Care About Environmental, Social, and Governance (ESG) Investing, https://www.wlrk.com/docs/BofA_ESG-10-reasons-you-should-care-about-ESG-Investing.pdf.
Comment, BlackRock, RE: Financial Factors in Selecting Plan Investments; 29 CFR Part 2550; RIN 1210-AB95 (July 30, 2020).
Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 39113 (June 30, 2020) (to be codified at 29 C.F.R. pt. 2550).
Martin Lipton, DOL Proposes New Rules Regulating ESG Investments, Harvard Law School Forum on Corporate Governance (July 7, 2020), https://corpgov.law.harvard.edu/2020/07/ 07/dol- proposes-new-rules-regulating-esg-investments/.
Press Release, U.S. Dep’t of Lab., U.S Department of Labor Proposes New Investment Duties Rule (June 23, 2020).
Trump Labor Department’s Rule Discouraging ESG Investing in Retirement Plans is Finalized Over Swell of Objections, MarketWatch (Oct. 31, 2020).