In mid-October, the US Department of Labor (DOL) proposed a
revised rule clarifying fiduciary responsibilities when selecting investment
options for defined contribution (DC) plans. In our view, the new rule is a big
step forward in encouraging fiduciaries to consider environmental, social and
governance (ESG) factors when designing plan investment menus.
The rule, formally known as “Prudence and Loyalty in
Selecting Plan Investments and Exercising Shareholder Rights,” sets out the
standards for key plan-sponsor duties. They include selecting plan investment
options, along with qualified default investment alternatives (QDIAs),
exercising shareholder rights—such as proxy voting—and the use of written
proxy-voting policies and guidelines.
Several recent twists and turns in ESG rulemaking
The proposed rule would revise the standards for plan
fiduciaries considering ESG in investment selection. It would supersede a
previous iteration of the rule finalized in November 2020, which included a
last-minute pivot from the DOL. The late change eliminated any references to
strategies with an ESG theme in ERISA plans, in the process removing language
that had elicited a strong negative response from the investment community.
At the time, we referred to the pivot as a welcome
development, because it smoothed out a wrinkle that might have inhibited some
DC plan sponsors from considering ESG investment options. In making the change,
lawmakers seemed to acknowledge our view (and that of many others) that
material ESG factors are indeed financial factors. While the rule removed
potential confusion, the investment community hoped for more tangible support
for plan sponsors considering ESG in designing investment menus.
Shoring up support for ESG in retirement plans
Under a new administration, the DOL decided to take a fresh
look at the rule in an effort to add greater clarity and increase support for
ESG considerations. The new proposed rule, in our assessment, would represent
Among the enhancements? It would explicitly recognize that a
plan fiduciary making an investment decision can consider ESG factors material
to the risk-return analysis. It also states that a prudent investment “may
often require” considering these factors. That’s a strong note of support for
plan sponsors when evaluating investment options.
The rule would also remove a number of special guidelines on
ESG considerations in QDIA selection; the same standard would apply to QDIAs as
applies to all other investment options.
And the rule would reduce the burdens of the “tie-breaker”
standard, which allows plan sponsors to consider “collateral benefits” in their
decision-making process, such as ESG factors that aren’t clearly material from
an economic perspective.
Another notable change in the DOL’s new rule is the
elimination of proxy-voting provisions that could have had a chilling effect on
plan fiduciaries from exercising their ownership rights as shareholders. ESG
proposals, from both company management and shareholders, can—and do—impact
shareholder value. We applaud the DOL for recognizing this point with the new
Where We Hope the Rule Can Go Further
In our view, material ESG considerations are financial
considerations. This is true whether it relates to an equity manager assessing
modern slavery risk in a clothing manufacturer’s supply chain, an analyst
gauging the impact of the net-zero transition on a utility or a plan sponsor
evaluating a purpose-driven investment strategy aligned with the United Nations
Sustainable Development Goals.
In our letter to the DOL during the rule’s open comment
period, we supported the proposed rule as a very positive measure. And, along
with the Defined Contribution Institutional Investment Association, we agree
that the rule brings us closer to a principles-based approach, where plan
fiduciaries incorporate the impact of material ESG considerations when
evaluating plan investments.
Are there areas that can be improved? Yes. As it stands, the
rule lists specific examples of ESG factors. But listing some ESG factors might
imply that others not listed aren’t relevant. Keeping the rule broad to
encompass any material financial factor would give plan sponsors more
flexibility. Also, eliminating the tiebreaker rule altogether would, in our
view, reduce confusion.
We welcome the proposed DOL rule, and we’re optimistic that
it can be enhanced further based on public comments. For DC plan sponsors, the
added clarification that ESG considerations can be material in evaluating
investments will provide comfort in incorporating ESG options more
proactively—and to talk to investment managers about ESG integration in
portfolio management. In fact, many plan sponsors are likely already using
investment managers that integrate ESG.
By fostering better plan investment menus, we believe that
the new clarity from the DOL rule—and additional suggested enhancements—can
ultimately lead to better outcomes.
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