New Labor Department Guidance Takes Aim at ESG Investing

A new proposal by the Labor Department will require retirement-plan fiduciaries to choose investments “based solely on financial considerations” and is aimed to slow the interest in environmental, social, and governance (ESG) investing, analysts say. There is $10.7 trillion in private pension plans.

The DOL administers and enforces Erisa, the federal law governing private retirement and health plans. The proposal will have a 30-day comment period. In an op-ed published in The Wall Street Journal Wednesday, Labor Secretary Eugene Scalia cited the swift growth of ESG investments, including soaring inflows and the signing by investors and businesses of the United Nations Principles for Responsible Investment. At the same time, he wrote, standards for ESG investing “are often unclear and sometimes contradictory” and often try to promote a social or political outcome.

“ESG factors often are touted for reasons that are nonpecuniary—to address social welfare more broadly, rather than maximize returns,” he wrote.

The proposed rule “reminds plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end,” Scalia continued. However, he noted that the fiduciary could look at nonpecuniary factors if two potential investments were economically indistinguishable.

“What year is this?” Joe Keefe, president of Impax Asset Management, which has a line of sustainable funds, told Barron’s. “There is a substantial body of research underscoring the materiality of ESG considerations at both company behavior and investment portfolio behavior,” he says. “This research is well-known and well-established at this point. It seems to have been ignored in this proposed rule.” For example, during the recent market downturn, sustainable companies were beating the market.

“We welcome the actions taken today to provide added protections for investors and retirees,” said Tom Quaadman, executive vice president at the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, in a statement. “Americans who are struggling due to the Covid-19 pandemic should not have to sacrifice part of their retirement income because of politics.... The new proposed rule makes investor return the central focus for workers’ pensions and employee retirement accounts.”

The proposed rule comes as firms like BlackRock, the world’s largest asset manager, said it would put sustainable investing at the heart of its plan for growth and push companies to report on sustainability metrics and vote against managements that don’t make sustainability disclosures.

In the wake of recent protests about race inequality in the U.S., BlackRock announced this week that it would substantially boost the proportion of black senior leaders and blacks in its workforce, as well as launch products focused on racial equity and social justice and engage with companies to promote workforce and leadership diversity. “This commitment to make change is core to our purpose, to who BlackRock is and the difference we can make in the world. It is also something our clients are looking for us to do,” CEO Larry Fink and President Rob Kapito wrote colleagues this week.

“The timing of this is directly correlated to the activity we’re seeing on racial justice, with big companies literally in the process of saying we need to do better,” says Matt Patsky, CEO of Trillium Asset Management, a sustainable investment boutique. “They [the DOL] are trying to slam the barn door closed and slow this down.”

In fact, investors are flocking to ESG for superior returns, according to a recent study by investment manager Nuveen. “Investors increasingly understand that promoting positive outcomes on important ESG issues not only minimizes portfolio risks, it actually leads to improved performance overall,” Amy O’Brien, head of responsible investing at Nuveen, said in a statement.

Meanwhile, in the wake of the Covid-19 pandemic and the protests about social justice, interest in ESG is growing, particularly from retirement plans. According to the same Nuveen study, 54% of investors said they would invest their entire retirement balance into a fully diversified responsible investment portfolio.

“The DOL has proposed U.S. investors take a significant step backward on responsible investing by seeking to prohibit selection of an ESG investment option as a default investment in a 401(k),” said Fiona Reynolds, CEO of Principles for Responsible Investment, a U.N.-backed advocacy group, in a statement. “This ignores the growing focus on and evidence of material ESG factors by investors around the world.... This is a risk to the U.S. pension market, but more importantly, a risk to U.S. savers.”

The proposed rule may confuse fiduciaries. Last year, President Donald Trump issued an executive order that pushed the DOL to examine how pensions use ESG metrics with their energy investments. The DOL, earlier in the Trump administration, had also walked back Obama-era guidance that said plans could consider ESG factors.

The Labor Department “is getting more and more concerned that the market is getting comfortable with pursuing social goals without ensuring that doing so doesn’t hurt retirement returns,” says Andrew Oringer, the Erisa group co-chair at law firm Dechert.

In the past, investors would need to argue that at the very least, ESG investing wasn’t hurting returns. Now, Oringer says, this will push investors to say “we actually believe this focus is a financial and economic advantage.”

Separately, the Securities and Exchange Commission is also weighing whether ESG funds need to follow existing rules that require their names to broadly match what they invest in.

Many asset managers have made a substantial investment in ESG, one of the faster-growing areas of the business.

“The problem with this guidance is that it confuses fiduciaries at a time when the evidence is clear that to ignore ESG issues is arguably in breach of your fiduciary duty because of all the evidence of their materiality” to shareholder returns, says Impax’s Keefe. “I expect the DOL will hear loud and clear from the investment community about this.”

Corrections & Amplifications

Joe Keefe is president of Impax Asset Management. An earlier version of this article mistakenly described him as the CEO of Pax World Funds.

Read the original article here.