New proposed rules for ESG investing were published in 2021. In November of 2022, the Department of Labor issued final regulations.
Over 200 comments were submitted regarding the proposed regulations, and the majority were favorable. The new rules largely follow the proposed rule but with a few significant changes. The rule follows an executive order signed by President Biden in May 2021 directing federal agencies to institute policies to protect against the threats of climate-related financial risk.
- ESG investing aims to generate returns by picking stocks based on environmental and social concerns and issues of corporate governance in addition to looking at the financial metrics of companies. ESG investing has grown rapidly as investors become increasingly concerned about such issues. Assets in ESG funds have increased in recent years and now are approaching $40 trillion. Even traditional asset managers who do not follow an explicit ESG strategy, are feeling pressure to adopt ESG policies requiring consideration of factors other than traditional financial criteria in evaluating companies.
- As administrations have changed, the Department of Labor has gone back and forth over the years on its position regarding ESG investing. Generalizing, Democrats endorse the concept while Republicans are skeptical.
- At the very end of the Trump administration, the Department issued final regulations on ESG investing which made it difficult for plan fiduciaries to add ESG options to plan investments. Almost as soon as President Biden took office, his administration announced it would walk back these rules. The back-and-forth in Washington regarding ESG investing has most certainly continued, most recently with President Biden’s veto on March 20, 2023 of a resolution to void the rule change.
Key takeaways regarding the final regulations:
- The core ERISA principle remains that the duties of prudence and loyalty require plan fiduciaries to focus on traditional risk-return factors in making investment decisions. The primary goal must be income security in retirement. Fiduciaries cannot sacrifice returns or take on additional risk in pursuit of other goals.
- Investment decisions must be consistent with the plan’s investment and funding policies, but the new rule allows plan fiduciaries to consider the economic effects of factors such as climate change, gender equality, and racial diversity.
- While the proposed rule was well received, there was some concern that it went beyond allowing plan fiduciaries to consider ESG factors to requiring this. The final rule makes it clear that while ESG factors may be taken into account in making investment decisions, it is not required.
- The longstanding “tiebreaker” standard is streamlined and confirms that if fiduciaries conclude that competing investments equally serve the financial interests of the plan, fiduciaries may consider collateral benefits other than investment returns.
- The same standard applies to QDIAs as to other investments—i.e., the focus should be on relevant risk-return factors. The “tiebreaker” standard may be used in selecting a QDIA and unlike the proposed rule, additional documentation is not required when this approach is used. This contrasts with the Trump Rule prohibiting using any investment as the QDIA that has an ESG component.
- Fiduciaries may consider participant preferences for ESG investments. The rule does not address how to deal with conflicting participant preferences which will most often be the case.
- The approach to proxy voting in the proposed rule is retained. This rule eliminates the special standards and presumption against fiduciaries exercising shareholder rights in the Trump rule. The final rule makes clear that the fiduciary duty to manage plan assets includes voting shareholder proxies.
