The US Department of Labor (DOL) two weeks ago announced a proposed rule that would remove barriers to the ability of pension trustees to take into account climate change and other environmental, social and governance factors. (ESG) when selecting investments and exercising shareholders’ rights.
Entitled “Prudence and loyalty in the selection of plan investments and the exercise of shareholders’ rights”, the proposal spans 109 pages and, as is the case with the course, includes fairly nuanced language that talks about obligations of trustees under the Employees Retirement Income Security Act (ERISA). Now that pension industry experts have had time to digest the proposal, many seem to like what they are seeing, with the initial consensus being that the rule should facilitate wider use of ESG factors by investors who have been claiming since. long such an expansion.
The proxy voting side of the proposal will be addressed in a later article, but comments from that side have also been largely positive.
John Hoeppner, head of stewardship and sustainable investments in the United States, Legal & General Retirement America, told PLANADVISER that he expected the DOL to provide clarification on the reasonableness of integrated ESG options, but he was “Delighted and surprised” to see the rule specifically calls for the use of ESG factors in investment options serving as a qualified default investment alternative (QDIA) of a pension plan.
“The signaling impact of this move is huge, in my opinion,” Hoeppner said, noting that his organization was “very concerned” about the ESG and proxy voting rules that had been implemented by the end of the year. Trump administration. According to Hoeppner, these rules were too restrictive and seemed linked to a more archaic perspective of the purpose and technical aspects of ESG investing.
“As for the comment period and the final rule, I expect this package can be tweaked slightly, but I think the main parts will remain,” Hoeppner said. “Then the real action happens when the first or the first handful of large defined contribution companies [DC] the plans publicly change their default option to an ESG option, when you get models like a Disney or a Ford heading in that direction. It will be a very big deal that could provide a significant impetus towards a more universal use of ESG investments in US pension plans. “
Julie Stapel, partner of the ESG and sustainable development group of Morgan Lewis, notes that the time of filing is significant. Basically, the fact that this proposal was made relatively early in the Biden administration means that it will have a lot more time to actually implement and gain momentum compared to previous administrations’ efforts to change the rules. in this domain.
“My overall first impression is that, if this is finalized in something like its project form, it will be very helpful to fiduciaries who have already started to embark on this path towards ESG investing,” said Stapel. “I think the Plan Trustees, as represented by the clients we work with, are in many different places along this route, due to various factors, but this proposal will make their travel much easier and more sure. “
Echoing Hoeppner’s comments, Stapel argues that the proposed rule is unlikely to result in a massive and sudden change of direction for the institutional retirement planning market, but it could prompt different parties to start thinking more seriously about l ‘ESG investment and, according to her, That’s a good thing.
“This proposal is a fairly unequivocal statement of DOL’s view that not only can ESG be an appropriate fiduciary consideration, but sometimes it must be,” she said. “I don’t think the DOL could have given a clearer endorsement of ESG investing under ERISA.”
QDIA Language Matters Most
Stapel says she thinks the QDIA portion of the proposal is significant, although she was less surprised to see it than Hoeppner, given her view that the Trump administration’s regulation in this area has caused a lot of confusion and dismay among the asset management community. and pension plan sponsors.
“The problem was that virtually all of the standard QDIAs that are so popular in the market already use ESG factors to some extent,” observes Stapel. “There were a lot of people wondering if their QDIA wasn’t playing by the rules. The proposal responds directly to this very real and important concern. “
In a blog post on the proposed rule, Sarah Bratton Hughes, Global Head of Sustainability Solutions at Schroders, says regulatory activity demonstrates the current administration’s view that ESG factors can often be a critical issue. in the evaluation of potential investments.
“If the final rule is passed largely as proposed, it would mark an important moment for the United States, but would also spark the interest of those working with sustainability rules in other investment markets,” he said. she declared. “The direction in the United States is now clear. The approach adopted before 2017 – and unwound by the previous administration – is coming back. We have gone back to the future.
ESG goes beyond climate change
As Bratton Hughes explains, although climate change is mentioned in the preamble of the proposal as a major potential risk affecting long-term returns, the DOL is clear that important ESG factors can address much more than simple climate change. To this end, it included several examples. Under the rubric of workforce practices, for example, the DOL cites as potentially financially significant a company’s progress in workforce diversity and its level of investment in promoting positive working relationships. In the context of governance factors, the DOL asserts that elements such as board compensation and transparency in company decision-making can be important, as can the avoidance of criminal liability of the company. a business and its compliance with labor, employment, environmental, tax and other laws.
Hoeppner, Stapel and Bratton Hughes all say the proposal’s “ESG tiebreaker” language is somewhat important. Currently, collateral ESG factors can only be seen as a tie-breaker when two competing investments are economically indistinguishable. In addition, the rules as they exist today impose significant documentation requirements, requiring investors to demonstrate that the tie-breaker has only been used in this limited context.
The proposed rule, on the other hand, would adopt a more general principle. Under this wording, when a trustee concludes that two competing investment approaches “also serve the financial interests of the plan”, the trustee could base an investment decision on “economic or non-economic benefits other than returns. on investment ”.
Bratton Hughes says the Biden DOL seems to think the special documentation requirements of the previous rule make it seem like trustees should be wary of ESG factors, even when those factors are financially important to the investment decision.
All three sources say this is a positive step forward for ESG investing in the United States
Potential changes and further interpretation
Stapel says there is one potentially important change she would suggest to the proposed rule.
“This relates to the section of the proposal called (b) (4),” she explains. “This section is where the proposal clarifies that trustees can take into account ‘everything that is important for the risk-return analysis of an investment.’ It would have been a good place to dot and stop – to keep the language as direct as possible. But the proposal goes on to give potential examples, such as climate change and several other things. I fear that these examples, because they are written in the proposal, may reduce the durability of this rule if and when we are faced with a change in administration. It only serves to alienate this language. To make this point more specific, I’m afraid that part of the proposal may involve politics, frankly. “
A team of lawyers from the Wagner Law Group also sent their interpretation of the proposal to PLANADVISER. They point out that the details of the proposed settlement will be considered by many different interested parties over the coming months, noting that public comments are expected on December 13.
“Unlike the 2020 rule, however, this proposed revision of the investment rights rule arguably creates more room for the neutral exercise of fiduciary power with fewer regulatory constraints,” they write. his predecessor did.
Another important point of analysis came from Josh Lichtenstein, a partner of Ropes & Gray ERISA.
“The rule may actually cause plan sponsors to seek out descriptions of the ESG characteristics of funds that are not ESG / impact funds,” he says. “Indeed, the rule, both in the text and in the preamble, evokes the importance of the economic aspects of ESG. The regulation states that investment considerations “may often require an assessment of the economic effects of climate change and other environmental, social or governance factors on the particular investment or investment action plan”. This could be interpreted as implying that plan sponsors must be able to justify any decision. not take ESG factors into account.