DoL Proposal “Reflects Reality” of US Demand for ESG Investing

Climate change “an imminent material financial” risk that US plan fiduciaries must consider, experts assert.  

A proposed new rule which explicitly allows US pension plans to consider ESG factors has been hailed as recognising investor consensus on the financial materiality of climate and other sustainability-related risks.  

The US Department of Labor (DoL) published on Wednesday a proposal that aims to reverse 2020 rules impacting pension plans, shareholders and proxy advisory firms, introduced under the Trump administration.  

The proposal “reflects the reality of burgeoning interest in ESG factors” in the US, Steven Rothstein, Managing Director of the Ceres Accelerator for Sustainable Capital Markets, told ESG Investor.  

It has been published following an executive order issued by US President Joe Biden in May, which directed federal agencies to assess and mitigate climate-related financial risks. The DoL’s proposal was first reviewed by the Office of Management and Budget (OMB) over the summer. 

“Today’s announcement is an important step towards ending the regulatory pendulum that is holding back the inclusion of funds utilising ESG criteria in retirement plans and complicating proxy voting by plan fiduciaries,” said Lisa Woll, CEO of US SIF, a forum for sustainable and responsible investment. 

The proposal allows for a 60-day comment period. 

ESG barriers falling away 

The first of the Trump administration’s widely contested rules stipulated that Employee Retirement Income Security Act (ERISA) plan fiduciaries cannot invest in ways that would sacrifice investment returns or take on additional risk, thus excluding the consideration of ESG-related factors. ERISA plans manage over US$15 trillion in AUM. 

While the US today is “polarised on many issues”, investors and companies increasingly recognise that “climate change poses an imminent material financial risk that fiduciaries must consider in selecting retirement investments,” said Rothstein. 

The Ceres Accelerator was launched by the sustainability non-profit last year to change capital markets practices and policies  to accelerate action on the global climate crisis and other sustainability threats.

As financial security is ensured by planning for the future, “it’s just common sense that ERISA fiduciaries be allowed to consider the [ESG] factors that are shaping the future,” Senators Patty Murray and Tina Smith said in a joint statement. 

The new rule, if enforced, would make it extremely clear that plan sponsors evaluating investments can consider ESG factors as economic factors.  

“It may even create a presumption that plan sponsors should be considering ESG factors as part of all investment decisions. If the rule is finalised in this form, many of the old barriers to ESG investing for ERISA plans should fall away,” said Josh Lichtenstein, ERISA Partner at law firm Ropes & Gray. 

The proposal also includes a ‘tie-breaker’ clause, allowing a fiduciary to consider the “collateral benefits” of selecting a plan investment on ESG grounds if the competing investments “equally serve the financial interests of the plan”.

Proxy voting revisions 

The second Trump-era rule reversed by the DoL proposal concerns the processes a fiduciary must undertake in order to cast a proxy vote 

The Trump rule included an explicit requirement that a plan fiduciary must monitor any third-party proxy voting service – such as Institutional Shareholder Services (ISS) and Glass Lewis – to which voting has been delegated. 

This requirement, which was scheduled to be fully enforced from December, would have required proxy advisory firms to provide companies with the information underpinning their voting recommendations to shareholders prior to voting at annual general meetings.  

As such, the ruling had the potential to impact the ability of shareholders to hold corporates accountable on ESG-related issues.  

“We applaud the DoL’s decision to propose rule amendments reaffirming the applicability of the fiduciary duties of prudence and loyalty to proxy voting, and removing language in the 2020 rules that could be read to suggest that fiduciaries should be indifferent to the exercise of shareholder rights,” said Gary Retelny, ISS President and CEO. 

SEC Commissioners Hester Peirce and Elad Roisman previously questioned the decision to reverse the proxy vote ruling. 

The new DOL proposal makes a number of other changes to existing proxy voting and exercise of shareholder rights provisions, covering the duty to vote, monitoring obligations and record maintenance.  

The US Securities and Exchange Commission’s (SEC) finalised proposal for a climate-related disclosure framework is expected to be published this month, according to SEC Chair Gary Gensler’s annual regulatory agenda. This would require all publicly-listed US companies to disclose their exposure to climate-related financial risks. Once published, it will be subject to public consultation before being enforced next year.  

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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