UPDATE: Biden orders review of Trump ESG order for investors

Signaling his across-the-board interest in climate change and social justice issues (see story links here, here, and here), President Joe Biden included in one of his early executive orders a mandatory review of an investment regulation that went into effect on 12 January 2021 to restrict consideration of corporate environmental, social and governance (ESG) programs as a risk factor.

The review is required under "Executive Order on Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis," issued on 20 January. Accompanying that executive order is a fact sheet that lists regulations that are to be reviewed and the agencies to review them.

The US Department of Labor (DOL) oversees investment advisers under the Employee Retirement Income Security Act of 1974 (ERISA), and on 30 October 2020, DOL announced a final rule that clarifies that financial advisers under ERISA should not consider ESG as one of the factors in making an investment decision.

The final rule builds on guidance issued by the agency in 2018 stating: "...fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision… [as it] does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors."

In the 2018 same guidance, DOL also stated that "a fiduciary's evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan's articulated funding and investment objectives."

ERISA attorneys have said they interpret the final rule as not fully banning ESG investment options, but allowing them only if they satisfy the "prudence" requirement elsewhere in ERISA, and if the advisor can show that investments were evaluated based on other pecuniary factors.

The Trump administration's rule can be read here.

While the rule went into effect on 12 January, retirement plan managers have until 30 April 2022 to make any changes to certain qualified default investment alternatives, where necessary to comply with the final rule.

DOL first proposed the new rule in June 2020, and it received more than 8,000 comment letters—many of them highly critical of the approach. The American Retirement Association (ARA), which represents five investment trade groups and more than 30,000 members, said the new policy was misguided. "The ARA does not believe that DOL guidance should discourage ERISA fiduciaries from considering environmental, social, governance factors as they evaluate plan investment options. The ARA believes otherwise-appropriate investments that include ESG factors should not be prohibited from qualifying as Qualified Default Investment Alternatives (QDIAs) or as a component of a QDIA," it told DOL in a comment letter when the June draft was issued.

ARA noted one recent survey found that 72% of the US population said it is interested in investing in ESG funds, and that a growing number of active fund managers (those who select investments rather than seek to track broad market performance) "are recognizing the materiality of ESG factors in evaluating investments."

However, the evidence is far from conclusive that ESG funds are better, worse, or basically equal to funds that don't consider those factors. While some companies appear to have their stock prices harmed by ESG issues-such as fossil fuel companies with large reserves of oil and natural gas that might be subject to a carbon tax or prohibited from production altogether-it's far from clear that ESG-oriented investing overall is a positive for a person's or retirement plan's portfolio. One commenter to the DOL rule, Alicia Munnell, director of the center for Retirement Research at Boston College, presented information that ESG funds performed 2-3 percentage points worse than a comparable Vanguard fund over a 10-year period ending in 2019.

ERISA

In saying that ESG has no place in ERISA at this time, DOL outlined several criticisms with how the emerging use of environmental, social, and governance factors are implemented. The agency said that because there is no single definitive definition of ESG, it is prone to "inconsistencies…lack of precision and rigor… [and is] vague and inconsistent." These problems can harm investors if financial advisers follow poorly designed ESG programs.

"Protecting retirement savings is a core mission of the US Department of Labor and a chief public policy goal for our nation," said US Secretary of Labor Eugene Scalia on 30 October. "This rule will ensure that retirement plan fiduciaries are focused on the financial interests of plan participants and beneficiaries, rather than on other, non-pecuniary goals or policy objectives."

ARA tried to turn that argument on its head, noting in its comment letter that the lack of consensus means that DOL was, basically, banning all considering of ESG because the agency was saying that it cannot decide which type of investment would be "prudent" under ERISA.

That argument didn't sway DOL. "Retirement plan fiduciaries vindicate the public policy behind ERISA-and comply with the law-when they manage plan assets with a clear and determined focus on participants' financial interests in receiving secure and valuable retirement benefits. Plan fiduciaries should never sacrifice participants' interests in their benefits to promote other non-financial goals," said Acting Assistant Secretary of Labor for the Employee Benefits Security Administration Jeanne Klinefelter Wilson on 30 October.

Posted 25 January 2021 by Kevin Adler, Editor, Climate & Sustainability Group, IHS Markit