Environmental, social and corporate governance (“ESG”) guidelines are growing in popularity among investors, but their use in retirement plans could face serious hurdles thanks to a recent Department of Labor decision.
On October 30, 2020, the Department of Labor (“DOL”) released a final ruling amending the “investment duties” regulation under Title 1 of the Employee Retirement Income Security Act of 1974 (“ERISA”). These amendments “require 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.”
All told, the DOL ruling effectuates five primary amendments:
- Adds provisions confirming that ERISA fiduciaries must evaluate investments based only on pecuniary factors – “financial considerations that have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and funding policy.”
- Includes an express regulatory provision stating that compliance effectively prohibits fiduciaries from sacrificing returns or taking on additional investment risk just to promote non-pecuniary goals.
- Includes a provision requiring fiduciaries “to consider reasonably available alternatives to meet their prudence and loyalty duties under ERISA.”
- Sets required investment analysis and documentation requirements should plan fiduciaries use non-pecuniary factors when choosing between investments they can’t distinguish based solely on pecuniary factors.
- States that ERISA’s prudence and loyalty standards apply to fiduciary’s selection of designated investment alternatives offered to participants and beneficiaries in a participant-directed individual account plan.
“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,” Labor Secretary Eugene Scalia said in a release.
One thing the final ruling doesn’t include is an explicit reference to ESG – but it is an assumed target of this resolution, as several restrictions and rules specifically governing ESG fund selection were included the original proposed resolution in June.
While explicit references to ESG have been removed, the fear is that interpretations of the rule will still dissuade fiduciaries from considering environmental, social and governance factors. With the results of the recent U.S. elections still undetermined as of the date of this article, the 2021 political environment could also be a major variable to consider when evaluating the impact of the new rule.