Nicholas Zaiko, CIMA
DOL Proposal to Restrict ESG Investing
European pension plans and institutional investors have long been prioritizing ESG investments. In the US, the acceptance of ESG investing by pension plans and defined contribution plans has lagged Europe but is continuing to gain traction. Interestingly, during the current COVID-19 pandemic, ESG funds have experienced large inflows and have performed well. Morningstar reports that over $24 billion have flowed into ESG-focused funds as of July 31, 2020 compared to $21 billion in 2019.
In June 2020 the DOL proposed guidance for fiduciaries when considering environmental, social, and governance (ESG) factors in the investments for ERISA defined benefit and defined contribution plans. The comment period closed July 31, 2020 and has met with strong investment manager resistance. The investment management community has emerged as strong proponents of ESG investments.
The DOL proposed rules would restrict the ability of defined contribution and pension plan fiduciaries to select investments that integrate ESG factors. It would also bar 401(k) plans and other DC plans from using any funds with any ESG mandates as the QDIA. This prohibition would certainly curtail the growth of ESG investments.
Previous DOL interpretive bulletins issued in 1994, 2008 and 2015 included the “tiebreaker rule” which permitted the consideration of other factors such as ESG in the selection of comparable investments. The proposal provides new guidance on selecting investment options for DC plans in which proposed options incorporate ESG considerations.
The proposed rule applies a higher fiduciary standard of prudence to investments that serve as a default. The proposal states that incorporating ESG factors in the QDIA could violate the “duty of loyalty.”
The DOL proposal creates an onerous prudent process for including ESG investments in ERISA-covered defined contribution and defined benefit plans. Key points include the following:
The duty of loyalty as defined by ERISA 404(a)(1)(A) requires fiduciaries to act in the best interests of plan participants and beneficiaries and not make investment decisions based on non-financial goals such as ESG.
Plan fiduciaries must select investments and based on financial considerations and their risk-adjusted returns and economic value. The DOL is making the assumption that ESG investments are risky and underperform other investments.
That fiduciaries must consider other investments to meet their duties of prudence and loyalty under ERISA.
Major investment managers such as BlackRock, Fidelity Investments, State Street Global Advisors, and Putnam Investments have responded in opposition to the DOL proposal and its assumptions. Many of the characterizations and assumptions made by the DOL were seriously challenged by the respondents. The DOL received 8,737 comments that were made public of which 95% of them opposed the DOL’s proposal.
The DOL is still targeting year-end 2020 for its final version of its ESG guidance.