Democrats and Republicans in Washington broadly view
retirement plan fiduciaries considering ESG factors in investment decisions
much differently, with the Trump and Biden administrations promulgating vastly
dissimilar regulations on the issue.
A new rule proposal from the Department of Labor, which
marks the latest move in a long-lasting regulatory fight, would explicitly
permit retirement plan fiduciaries to consider climate change and other
environmental, social and governance factors when selecting investments and
exercising shareholder rights.
The proposal, which was unveiled Oct. 13 and has a 60-day
comment period that concludes Dec. 13, is starkly different from two rules
finalized in 2020 during the Trump administration. The proposal should give
plan fiduciaries more comfort in integrating ESG factors into their plan
lineups, sources said.
"I think this will quite clearly accelerate the
incorporation of ESG factors into investment decision-making by ERISA
fiduciaries," said George Michael Gerstein, co-chairman of the fiduciary
governance and ESG groups at Stradley Ronon Stevens & Young LLP in
Washington. "The rule will give plan sponsors enough cover, so they'll
feel confident incorporating ESG factors."
Mr. Gerstein added: "If you look at the big picture, I
think the mission is accomplished in terms of clearing the air, taking the
stigma away, reminding folks that ESG is really important to consider, and
that's what this proposal does."
The proposal, called "Prudence and Loyalty in Selecting
Plan Investments and Exercising Shareholder Rights," makes clear
"that climate change and other ESG factors are often material and that in
many instances fiduciaries … should consider climate change and other ESG
factors in the assessment of investment risks and returns." It comes after
months of stakeholder outreach on the subject and follows an executive order by
President Joe Biden in May directing federal agencies to assess and mitigate
financial risks related to climate change.
Going mainstream
Julie K. Stapel, a Chicago-based partner at Morgan, Lewis
& Bockius LLP, said there are some plan fiduciaries who have been waiting
for the greenlight from the Labor Department on this issue for years, but the
regulatory "pingpong" may give other fiduciaries pause. If a plan
fiduciary is still uncertain about incorporating ESG factors into plan
investment decision-making and plan lineups, "I do think the possibility
of a reversal in as little as three-and-a-half years could continue to give
them pause," Ms. Stapel said, referring to the 2024 president election.
But the most recent Labor Department proposal has a greater
chance of surviving long term because it was proposed and could be finalized in
the early days of the Biden administration, said Joshua A. Lichtenstein, an
ERISA and benefits partner in New York who heads Ropes & Gray LLP's ERISA
fiduciary practice. "Even if there is a change in administration in 2024,
the rule will have presumably been final and effective for a long enough period
of time that people will be pretty heavily invested and reliant on it, and if
that's the case, then I think it becomes harder to pull back the rule," he
said.
ESG investing has become more mainstream in recent years,
said John Hoeppner, Chicago-based head of U.S. stewardship and sustainable
investing at Legal & General Investment Management America Inc.
"There's been a maturing of the whole industry while this kind of tennis
back-and-forth has been happening," he said. "I don't think the
debate will ever calm down, but perhaps the baseline is shifting."
Added Mr. Lichtenstein: "I think that the investment
world is just moving more and more toward ESG, and so when you get to 2024, I
think that if a new administration did really want to carve this back, they
might face the very real commercial issue (that) it might become really
limiting for ERISA plans to go back to not investing in ESG at all," he
said.
It's unusual for a new administration to change a final
regulation the way the Biden administration is proposing to change the Trump
administration's rules on this issue, Mr. Lichtenstein noted. But the Trump
administration's rules were also unusual in how quickly they were finalized —
with shorter than usual comment periods — and how soon they took effect before
the Biden administration took office.
However, the most recent proposal "could reflect a new
norm at DOL where there will be less of an idea of deference to prior final
regulations," Mr. Lichtenstein said.
The proposal is premised on the issue of financial
materiality rather than the political leanings of different administrations,
said Ali Khawar, acting head of the Labor Department's Employee Benefits
Security Administration, at Pensions & Investments' Defined Contribution
West conference in San Diego on Oct. 26.
"We try to make it clear that increasingly the market
recognizes that ESG can be a material financial factor, and when it does, it's
appropriate for the fiduciaries to take it into account," he said.
However, the Labor Department also "makes it clear that
ESG isn't by definition material, and it isn't by definition something that
you're required to always make sure that you're taking into account," he
added.
"The thrust of our proposal is that the fiduciary is
the person that's in the driver seat, and they are the ones that should be
making that decision about whether or not it is material."
Major change
Prior to the Trump administration, the Labor Department
consistently issued guidance mandating that plan fiduciaries make investment
decisions solely in the interest of plan participants, but how ESG factors fit
into that decision-making, as well as the tone and nuances, have varied with
the issuing administration, Ms. Stapel and her Morgan Lewis colleagues
explained in a blog post last year.
In 2020, under the Trump administration, the Labor
Department finalized two rules — one called "Financial Factors in
Selecting Plan Investments," which stipulates that ERISA plan fiduciaries
cannot invest in "non-pecuniary" vehicles that sacrifice investment
returns or take on additional risk; and the other, "Fiduciary Duties
Regarding Proxy Voting and Shareholder Rights," which outlines the process
a fiduciary must undertake when making decisions on casting a proxy vote. Both
rules drew sharp criticism from the plan sponsor and sustainable investing
community.
In March, the Labor Department said it would not enforce
either of the Trump administration's rules.
The financial factors rule excludes a fund from being a
qualified default investment alternative if its investment objectives, goals or
principal investment strategy include or consider the use of one or more
non-pecuniary factors. It was finalized in November 2020 and took effect Jan.
12, just days before the Biden administration took office. Mr. Biden signed an
executive order on his first day in office ordering a review of the rule. It's
often referred to as the "ESG rule" because the initial proposal,
which was unveiled in June 2020, focused on ESG investment factors, but the
final rule walked back the ESG language.
The proposal unveiled Oct. 13 would remove the special rules
for QDIAs that apply under the Trump administration rule, which Mr. Hoeppner
said was crucial.
QDIAs are "the crown jewel of (the defined contribution
market) and maybe I had underestimated how significant calling it out or not
calling it out is to set to the tone for the rest of the industry," he
said. "If it's not good enough for the QDIA, then does it really make
sense that it could be another option?" he said.
Congressional efforts
In May, Democrats in the Senate and House introduced a bill
that is similar to the Labor Department proposal: it would amend ERISA to make
clear that retirement plans may consider ESG factors in their investment
decisions and that ESG investments are permitted as qualified default
investment alternatives in ERISA-covered plans.
Passing a bill in Congress would provide stakeholders with
more peace of mind because a law is harder to change than a regulation, sources
said.
Sen. Patty Murray, D-Wash., chairwoman of the Senate Health,
Education, Labor, and Pensions Committee, has welcomed the Labor Department
proposal, but said Congress can do more. Ms. Murray introduced the Financial
Factors in Selecting Retirement Plan Investment Act in the Senate in May with
Tina Smith of Minnesota.
"It's important we give people certainty the progress
represented by President Biden's proposed rule is here to stay, which is why
I'm going to continue pushing to get the bill Senator Smith and I introduced
passed into law," Ms. Murray said in a statement to Pensions &
Investments.
But with Democrats narrowly controlling Congress, passing a
bill on ESG could be difficult, sources said.
"If Congress actually acted then they could end any
ambiguity, I think, but I think the likelihood of that happening is just very,
very small," Mr. Lichtenstein said. "But I do think the department
has done enough with this proposal where it should really increase the comfort
levels for ERISA plans that want to invest ESG funds, as long as they're
investing in those funds based on financial considerations."
Ms. Stapel called passing legislation on this issue "an
incredibly uphill battle." She added: "I think it's so unlikely to
happen that I can't even wrap my head around it. If it did happen though, I
think that would be helpful because then people would not feel like they're on
a four-year or eight-year pendulum."
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