The U.S. Department of Labor (DOL) has proposed removing
barriers put in place by the prior administration that would have limited plan
fiduciaries' ability to consider climate change and other environmental, social
and governance (ESG) issues as risk factors affecting workers' financial
security when fiduciaries select retirement plan investments and exercise
shareholder proxy voting rights.
The proposed rule, Prudence and Loyalty in Selecting Plan
Investments and Exercising Shareholder Rights, would apply to investments
included in 401(k) and other defined contribution plans, as well as to defined
benefit pension plans. The proposal, published in the Federal Register on Oct.
14, follows an executive order signed in May by President Joe Biden directing
the federal government to treat climate change as a threat to workers'
retirement savings.
In 2020, the administration of former President Donald Trump
had issued a final rule, subsequently blocked by the Biden administration, that
would have required sponsors of investment-based employee plans to strictly
apply the fiduciary duties of prudence under the Employee Retirement Income
Security Act (ERISA) when considering plan investments that promote
nonfinancial objectives, such as reducing carbon emissions. A separate Trump
administration final rule would have barred retirement plan fiduciaries from
casting corporate-shareholder proxy votes in favor of social or political
positions that don't advance the financial interests of retirement plan
participants.
Duties of Prudence and Loyalty
Under the Biden administration, the DOL takes the position
that ESG factors, and climate change issues in particular, pose financial risks
that plan sponsors should consider as prudent fiduciaries.
According to a DOL fact sheet, the proposed rule
"retains the core principle that the duties of prudence and loyalty
require ERISA plan fiduciaries to focus on material risk-return factors and not
subordinate the interests of participants and beneficiaries (such as by
sacrificing investment returns or taking on additional investment risk) to
objectives unrelated to the provision of benefits under the plan," a
position similar to the prior guidance.
The proposed rule, however, also "addresses the [DOL's]
concern that the 2020 [Trump administration] rules have created uncertainty and
are having the undesirable effect of discouraging ERISA fiduciaries'
consideration of climate change and other ESG factors in investment decisions,
even in cases when it is in the financial interest of plans to take such
considerations into account."
Acting Assistant Secretary for the Employee Benefits
Security Administration Ali Khawar said the new proposal "will bolster the
resilience of workers' retirement savings and pensions by removing the
artificial impediments—and chilling effect on environmental, social and
governance investments—caused by the prior administration's rules."
He added, "A principal idea underlying the proposal is
that climate change and other ESG factors can be financially material, and,
when they are, considering them will inevitably lead to better long-term
risk-adjusted returns, protecting the retirement savings of America's
workers."
A 'Significant Change'
According to R. Sterling Perkinson, a partner in the
Raleigh, N.C., office of law firm Kilpatrick Townsend, the proposed regulations
"represent a significant change in the DOL's viewpoint of fiduciary duties
that relate to ESG factors and shareholder activism, but they do not
fundamentally alter the fiduciary duties to make investment decisions and to
vote proxies and exercise shareholder rights to enhance investment returns.
They may nevertheless have an impact by removing potential barriers from
selecting funds that, for example, take into account climate change impacts or
corporate governance practices as part of their investment strategies."
Looking ahead, Perkinson noted, "It remains to be seen
whether the DOL will go a step further in final regulations by mandating
consideration of certain ESG factors, or whether they will maintain a more
neutral position that they are no different than other traditional investment
criteria."
Along those lines, retirement plan consultancy October Three
highlighted the section of the proposal stating that a fiduciary, when
evaluating a plan investment, must generally give appropriate consideration to:
"The projected return of the portfolio relative to the
funding objectives of the plan, which may often require an evaluation of the
economic effects of climate change and other environmental, social, or
governance factors on the particular investment or investment course of action.
[Emphasis added.]"
The firm advised that "the italicized language, added
by this new proposal, can be read not just to authorize consideration of ESG
factors but to require it 'often.' "
ESG Default Investments
The proposed rule reverses the prior rule's prohibition on
using ESG funds as qualified default investment alternatives (QDIAs), which are
types of mutual funds that plan sponsors can select as the default option in
automatic enrollment 401(k)-type defined contribution plans.
QDIAs can be target-date retirement funds, which
automatically reset their asset mix to become less risky as the specified
target retirement year nears. Mutual fund companies have begun marketing
target-date funds made up of investments that meet their ESG criteria.
"This will be a huge win, if the final rule ends up
looking like the proposal, for some asset managers who rolled out ESG
target-date funds over the past few years," Jason Roberts, CEO of the
Pension Resource Institute consultancy in San Diego, told RIABiz, an online
publication for investment advisors.
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