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New US Rule Limiting ESG Investments Criticised Despite Compromise

Department of Labor finalises restrictions of retirement plans before poll,  but still faces legal, electoral challenges.

The US Department of Labor (DOL) has failed to provide any rationale or supporting evidence in its final version of a rule which restricts the scope for pension plans to incorporate ESG factors into investment strategies, according to US SIF, the US Forum for Sustainable and Responsible Investment.

“In their effort to limit the use of investments that consider ESG issues in worker retirement plans subject to ERISA, the DOL did not provide any rationale for the proposed rulemaking. It provided no evidence that plan fiduciaries have been inappropriately selecting ESG investments or that ESG-focused funds have given up returns in exchange for ‘non-pecuniary’ benefits,” said US SIF CEO Lisa Woll in a statement.

The final version of the new rule – which impacts employer-sponsored retirement plans schemes and 401(k) plans governed by the Employee Retirement Income Security Act (ERISA) – was published on October 30, just over four months since it was first proposed. The rule becomes effective 60 days after publication in the Federal Register.

The rule requires ERISA plan fiduciaries to conduct stringent evaluations of ESG investments and limits use of ESG-themes funds as a pension plan’s qualified default investment alternative. It means retirement plan fiduciaries must make decisions “based solely on financial considerations” in selecting investments or making investment decisions.

The new ‘Financial Factors in Selection Plan Investments’ rule modifies prior DOL guidance, which allowed fiduciaries to select an ESG fund over an alternative if the two funds were judged to be otherwise equivalent. Although the final version included some concessions to criticisms made during its consultation phase, giving fiduciaries more latitude to consider material ESG-related risks, its main thrust remained unchanged.

“This final rule simply reflects the problems evident in the proposed rulemaking. It is an effort to limit the use of ESG criteria in investments. Abundant data debunks the premise that utilisation of ESG criteria is problematic,” added Woll.

US SIF said the DOL’s decision to allow only a 30-day comment period and then rapidly finalise and submit the rule was “unprecedented”, reflecting the department’s desire to pass the measure before presidential and congressional elections on November 3. “This is not sound policy-making,” it added.

The body had previously suggested the DOL could be in breach of the Administrative Procedure Act by shortening the typical 18-month process for finalising such an impactful rule change to less than four and a half. As well as the prospect of a court challenge, the rule could also be undone by a victory for former Vice President Joe Biden in the presidential election.

US SIF said it is increasingly common standard practice for US investment managers to consider ESG factors in order to assess long-term risk, return and fiduciary considerations. It said the new rule would now place “a substantial burden on fiduciaries” who consider ESG factors in retirement plans, as they would need to provide additional documentation to justify their financial materiality.

Last month, research published by Cerulli Associates found that defined contribution (DC) asset managers expect the new DOL rule to present a “significant barrier to adoption” of ESG products in DC plans. ESG investment products have yet to feature strongly in corporate DC plans, with only about 3% of 401(k) and profit-sharing plans included an ESG investment option as of year-end 2018, according to the Plan Sponsor Council of America.

Despite the potential barriers to adoption created by the new rule, 56% of defined contribution investment-only asset managers expect to increase their DC-focused ESG marketing and distribution efforts during the next 12 months, according to Cerulli.

An earlier analysis of 8,700 responses to the DOL consultation on the new rule, conducted by US SIF, found that 95% of commentors opposed the proposal and 94% of comments from investment professionals opposed it. “The rule will create confusion in the entire retirement market about the ability to offer funds that utilise ESG criteria. We realize that this is the intention of the Department of Labor, but it is wrong and most importantly, short-sighted,” said Woll.

In recent series of policy recommendations for the next US administration, US SIF called for the creation of an Office of Sustainable Finance and Business at the White House and the appointment of leaders with sustainable investment expertise at both the DOL and the Securities and Exchange Commission.

According to Fiona Reynolds, CEO of the Principles for Responsible Investment, the DOL’s new rule fails to provide clarity for fiduciaries and adds to confusion about when ESG factors may be considered material.

“Despite recognising the impact ESG factors can have on the value of an investment, in proposing the new rule the DOL is actively trying to prevent investors from considering those factors in their investment decisions. Getting in the way of progress on the integration of ESG considerations is a risk to the US pension market, but more importantly, a risk to US savers,” she wrote in a recent blog on The Hill.

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