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Biden’s DOL will review ESG rule

New President takes action on Day One

Jon Hale, Medium

Amidst the flurry of Executive Orders signed by President Biden on Inauguration Day was one sounding the death knell for the Trump Department of Labor’s recent rule limiting the consideration of ESG factors in retirement plans regulated under ERISA.

The Executive Order on Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis directs all executive departments and agencies to immediately review any regulations from the last 4 years that fail to:

  • empower workers and communities,

  • promote and protect public health and the environment,

  • advance environmental justice,

  • and confront the climate crisis.

In so doing, the order requires that these reviews “be guided by the best science and be protected by processes that ensure the integrity of Federal decision-making”.

This directive puts the so-called ESG rule promulgated by Trump’s Department of Labor last year firmly in its cross-hairs. Officially titled, “Financial Factors in Selecting Plan Investments,” 85 Fed. Reg. 72846 (November 13, 2020), the rule requires a retirement-plan fiduciary to base decisions solely on “pecuniary” factors. While the final rule seems to allow the consideration of ESG factors if they are financially material, it doesn’t make clear how that determination should be made and it only allows the consideration of “non-pecuniary” ESG factors in the rare circumstance when an investment decision cannot be made on pecuniary factors alone. In no cases, however, can “non-pecuniary” ESG factors be used in the designated qualified default investment alternatives (QDIAs) that soak up most of the money invested in defined-contribution plans.

For avoidance of any doubt, the rule was specifically listed among the actions required for review in a Fact Sheet released by the Biden Administration after the EO was signed. It was one of 104 actions called out for review, and the only one promulgated by the Department of Labor.

Once the DOL’s new leadership is in place, it shouldn’t take long before we see action taken. President Biden has nominated Boston Mayor Marty Walsh to be Secretary of Labor, but the Senate has not yet confirmed the nomination. Still to be nominated is the Assistant Secretary heading the Employment Benefits Security Administration, which will be responsible for reviewing the rule.

In the meantime, the rule took effect on January 12, 2021. It is important to note, however, that retirement plans have until April 30, 2022 to bring their QDIAs into compliance. That means if a plan already has an ESG fund as a QDIA, it should be able to sit tight while waiting for further guidance from DOL. For plans considering ESG options or considering adding ESG funds to their QDIAs, most, I’m hearing, are putting those moves on hold pending further clarification of the rule.

The rule is clearly inconsistent with the policy set forth in President Biden’s EO. First, the Trump DOL did not “listen to the science” in promulgating the rule, despite receiving overwhelming evidence in public comment about the efficacy of considering ESG concerns to improve the long-term risk-adjusted returns of investments in worker retirement plans. Ample evidence exists that ESG concerns do not harm investment performance, and much of it suggests superior long-term risk-adjusted performance is possible. Furthermore, the rule completely ignored evidence that ESG risks, especially climate risks, are financially material across a range of investments, a reflection of the previous administration’s blanket policy of climate-science denial.

Second, the EO states that the Biden Administration’s policy is to protect our environment, reduce GhG emissions and bolster resilience to climate change, among other things. By requiring retirement-plan fiduciaries to ignore these issues, the rule harms workers’ ability to finance and enjoy their retirement by forcing them into investments that will be laggards in the transition to a low-carbon economy.

While the final rule dropped specific references to ESG in favor of the pecuniary/non-pecuniary language, the full summary and background information published in the Federal Register made clear that limiting ESG was its primary purpose. It also failed to make clear that a broad range of ESG factors may be financially material and therefore included within its definition of pecuniary factors that are permitted to be considered by retirement fiduciaries.

My view is that the Biden DOL should drop the pecuniary/non-pecuniary framework entirely in favor of simply saying that ESG factors are generally financially material and therefore appropriate considerations for retirement fiduciaries in selecting plan investments. This is, after all, the overwhelming view of investment professionals globally.

For strategies that incorporate ESG concerns in ways that are somehow not financially material, fiduciaries should only have to show that the financial performance of such strategies are competitive on a risk-adjusted basis with similar strategies that don’t factor in ESG concerns.

A legislative solution to this end would be even better. Rep. Andy Levin (D-Mich) introduced a bill in December that would amend ERISA to make clear that retirement-plan fiduciaries can consider ESG in their investment decisions, including using strategies with ESG mandates as QDIAs. That bill will have to be reintroduced in the new Congress.

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Some additional thoughts from my colleague Aron Szapiro, Morningstar’s head of policy research:

“[R]ather than avoiding ESG analysis, we believe that 401(k) plan investment committees should have an obligation to consider ESG risk. Doing so is fundamental to evaluating the long-term performance of an investment. For instance, firms without a plan to cope with climate change may be caught flat-footed in the face of new regulation or environmental realities. And beyond being an issue of investor preference, human capital management is a financially material concern given the reputational and regulatory risks that companies face if they have poor labor relations. Many large asset managers already integrate ESG factors into their analysis for exactly this reason.”


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