The Department of Labor's Proposed ESG Rule: What It Means for Retirement Plan Sponsors
On June 23, 2020, the Department of Labor (DOL) issued a proposed rule that includes amendments to the investment duties regulation under ERISA that would “confirm that ERISA requires plan fiduciaries to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.” More commonly known as the “Proposed ESG Rule,” the rule, if finalized, would prevent an environmental, social and governance (ESG) consideration from being used as a factor in selecting investments unless it was also a “financial consideration,” as described above. Thus, the rule may have a significant impact on the future of ESG investing in retirement plans.
As is the case with most regulatory guidance, from the perspective of retirement plan sponsors and those who work with them, there are some positive and not-so-positive elements. Let’s take a look in greater detail at what the proposed rule means for retirement plan sponsors.
One positive takeaway for retirement plan sponsors from the finalization of a new rule would be that there is a rule. ESG investing has been around for decades, but up until now, the DOL has only provided pieces of sub-regulatory guidance, and those have conflicted with one another. Thus, while the rule may not satisfy ESG proponents, definitive guidance is better than unclear guidance.
Another positive is the rule’s emphasis on the notion that providing a secure retirement for participants is the goal of retirement plans, and that this goal should not be sacrificed for the benefit of other goals, no matter how noble (e.g., ESG factors). The vast majority of plan sponsors currently utilizing ESG funds are not sacrificing the goal of providing a secure retirement for participants, since ESG funds must pass the very same screens that a non-ESG fund needs to pass, in order to be included in the plan. (It would be rare to see an investment policy statement with separate criteria for ESG funds).
Given the current lack of ESG investing in retirement plans, the regulation appears to be a solution in search of a problem. It has been reported that the DOL cited aggressive marketing of ESG funds as a reason for the proposed rule, in addition to requests for information from plan sponsors. However, if there was such an aggressive ESG marketing campaign, examples likely would have surfaced by now, and have yet to be seen.
As a growing number of non-ESG funds incorporate ESG factors into their management, the “problem” that the DOL thinks it is solving may ultimately be moot. There is a possibility that in the future there will essentially be no such thing as a “non-ESG” fund.
The proposed rule also prevents ESG funds from serving as a Qualified Default Investment Alternative (QDIA). Thus, even if an ESG investment satisfies the investment policy statement screens and has performance metrics that make it the best fund for the plan (based on objective performance measures), it still cannot serve as the plan’s QDIA.
The rule does not break much ground, in terms of what prudent fiduciaries should be doing in the monitoring and selection of investments, as it states that fiduciaries must use the same objective risk-return criteria in selecting and monitoring all of the plan’s investment options, regardless of ESG status. However, the perception that the rule is “anti-ESG” may have the chilling effect of discouraging plan sponsors from even considering ESG investments in the future. This would be unfortunate, since a small, but growing, group of plan sponsors have proven that ESG investments can be successfully implemented into fund lineups, with no sacrifice in performance.
The particularly menacing component of this rule is the exceptionally short comment period of 30 days, a shared feature of the proposed Fiduciary Rule. Such a brief comment period suggests that the DOL may be trying to finalize the rule before any potential change in presidential administration. Retirement plan sponsors deserve an exemplary rule that can withstand the test of changing administrations. Hopefully, we will arrive at such a rule, regardless of the time it takes.
Interest in ESG investing has grown in recent years. While investing in companies that are socially and environmentally conscious is not a consideration for all investment strategies,
for those retirement plan sponsors trying to match the moral and ethical expectations of their plan participants to their investment offerings, the way in which they approach ESG-focused investment strategies has been a point of confusion. The new proposed ESG rule should help to clarify expectations but may ultimately limit the ability to include such funds in a retirement plan investment array.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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