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Law Change Needed to Protect ESG Rules for US Pension Plans

ERISA pensions now permitted to incorporate material ESG factors into their investment, voting decisions. 

The US Department of Labor’s (DOL) new rule allowing Employee Retirement Income Security Act (ERISA) pension plans to incorporate ESG considerations into their investment and voting decisions is “a step in the right direction”, but more needs to be done to prevent “regulatory ping pong”. 

“The new rule walks back a lot of what the Trump administration put in place,” Gregory Hershman, Head of US Policy for the UN-convened Principles for Responsible Investment (PRI), told ESG Investor. 

“But there is still concern because, while it changes the interpretation, this doesn’t actually change the underlying law. The most clear-cut action to take would be for Congress to alter the underlying law to ensure it clearly states that ESG can and should be considered by ERISA plans.” 

Published Tuesday, ‘Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights’ clarifies that a fiduciary of pension plans can consider ESG as a material factor that can inform their investment and proxy voting decisions. It follows an executive order signed by President Joe Biden in May 2021 and serves as a direct reversal of two rules issued in 2020 by the former President Trump administration, which the DOL this week said “unnecessarily restrained plan fiduciaries’ ability to weigh [ESG] factors when choosing investments, even when those factors would benefit plan participants financially”.  

The DOL is taking a neutral approach, stopping short of confirming that plans should consider all ESG-related factors as material, leaving that decision up to the pension schemes themselves.  

“In reality, the rule is catching up to where the marketplace has been for years,” said Lisa Woll, CEO of the US Sustainable Investment Forum (US SIF). 

“Investors understand that it is important to take into account how a company treats its workforce, whether it pays its fair share of taxes, their political spending, its supply chain, and whether the company is ready for the transition to a low-carbon economy. The final rule helps to address the gap between the growth of sustainable investment overall and the much more limited growth of sustainable investment options in retirement plans.” 

The rule reversal is also in line with what pension plan participants want, according to Schroders’ 2022 US Retirement Survey. Seventy-four percent of defined contribution pension beneficiaries who lack or don’t know if they have ESG options in their plan said they ‘might’ or ‘would’ increase their contribution rate if offered ESG options. Further, of the 31% of 401k plan participants that knew their plan offered ESG options, nine out of ten were invested in those options. 

“There is now a lot of opportunity for US-based asset managers to introduce products that fit pension plans’ ESG-focused demands,” added Hershman. 

The new rule will be formally adopted 60 days after it’s published in the Federal Register, although there will be delayed applicability until one year after publication for certain proxy voting provisions “to allow fiduciaries and investment managers additional time to prepare”, the DOL said. 

Anti-ESG backlash 

With a Republican-led House and a split Congress, it’s unlikely there will be enough support to change the law, which means the next administration could overwrite the DOL’s new rule and reinstate Trump’s anti-ESG measures, warned Hershman.  

While acknowledging this ongoing pendulum swing “isn’t practical”, he noted: “We have at least two years until a new administration comes in and potentially changes the rules again. That process, too, will take around a year to finalise.” It’s therefore important for pension plans to capitalise on that timeframe to fully incorporate ESG-related considerations into their investment and voting processes, he said. 

Anti-ESG rhetoric and actions by certain Republican-led states has limited the climate-related ambitions of actors in the US finance sector. US banks threatened to leave the Net Zero Banking Alliance (NZBA) due to potential legal risks resulting from intensifying political pressure to maintain their support for fossil fuel industries. Civil investigative demands for documents about their involvement in NZBA were sent by US state attorney generals to JP Morgan, Goldman Sachs, Bank of America, Citigroup, Wells Fargo, and Morgan Stanley. 

In addition, some states have withdrawn business from asset managers which factor ESG risks and opportunities in to their investment processes, while others have imposed anti-ESG requirements.  

“What we need is to educate everyone, including those pushing back against ESG, to help them understand it is merely an evolution of standard investment practices as ESG-related issues become more financially material,” said Hershman. 

“The vast majority of the rest of the world continues to understand the fundamentals of responsible investment; they continue to not only incorporate them, but to accelerate them. There is a risk that parts of the US are out of step with the rest of the global financial community.” 

Sustainable investment pipeline 

A number of policy and regulatory developments have supported the growth of sustainable investment opportunities in the US this year.  

President Biden demonstrated the increased climate-related ambition of his administration by signing the Inflation Reduction Act (IRA) into law, committing around US$370 billion in investment to reducing emissions and upscaling domestic renewable energy sources. 

Under Biden, the US Securities and Exchange Commission (SEC) has also been developing and finalising a number of ESG-focused rules. Among them are rules for green fund labelling, as well as disclosures on executive pay and diversity, equity and inclusion. 

Its much-anticipated climate risk disclosure rule for publicly-listed US companies will require disclosures on material climate-related risks, including their greenhouse gas (GHG) emissions. 

Originally scheduled to be finalised this year, a technology glitch forced the SEC to re-open the consultation until 1 November, delaying the final ruling until at least Q1 2023. 

“Many of the same companies that have announced ambitious GHG goals to reduce climate risk nonetheless insist that federal law prohibits them from considering climate or other ESG risks in employee retirement plan options,” said Danielle Fugere, President and Chief Counsel at US-based shareholder advocacy NGO As You Sow. 

“[The DOL’s new ERISA rule] demonstrates that nothing could be further from the truth. Today’s rule should prompt reconsideration by companies that are willing to address climate risk when it impacts their bottom lines, only to claim their hands are tied when it comes to protecting their employees’ retirement funds.” 

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