Roughly half (48%) of defined contribution investment-only asset managers say a new proposal from the Department of Labor concerning environmental, social and governance investing will be a significant barrier to adoption of ESG products in DC plans, according to research published Thursday by Cerulli Associates.
But the proposed regulation is not slowing down marketing and distribution efforts promoting DC-focused ESG products, as 56% of DCIO asset managers expect to increase these efforts during the next 12 months, said the report titled "U.S. Defined Contribution Distribution 2020: Adapting to Changes in the Regulatory Environment."
In June, the Labor Department unveiled a proposal to add regulatory text that makes clear that the Employee Retirement Income Security Act requires plan fiduciaries in both private defined benefit and defined contribution plans to select investments "based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action," as stated in a Labor Department fact sheet.
The proposal also includes a provision that eliminates the possibility that an ESG fund — themed or not — can be a qualified default investment alternative or even part of a QDIA.
More than 1,500 comment letters were filed during a 30-day comment period. Broadly, stakeholders said the Labor Department did not sufficiently justify its reasoning behind the proposal and said the proposal would create barriers for considering ESG risks; add to fiduciary confusion regarding if and when ESG factors may be considered material; and lead to increased documentation costs.
"For now, implementing ESG-themed products within a plan's QDIA is not a viable option from a fiduciary standpoint," said Shawn O'Brien, senior analyst at Cerulli, in a statement. "However, DC asset managers relate that some of their plan sponsor clients continue to express interest in ESG investments."
According to the Cerulli report, many asset managers tout performance-related benefits to incorporating ESG criteria into their investment analysis, even within non-ESG-branded funds.
"Many asset managers stand behind the financial merits of ESG," Mr. O'Brien said. "Some asset managers tell us they employ ESG screening processes or incorporate ESG factors into their investment analysis across all of their funds."
Three-quarters (75%) of asset managers cite mitigating risk as a top reason for incorporating ESG criteria into their investment analysis and more than two-thirds (68%) indicate incorporating ESG criteria leads to improved alpha opportunities, according to the report.
Also, because there are no universally accepted definitions and terminology concerning ESG, providers should consider "taking a step back to address the fundamentals of ESG investing in order to facilitate more nuanced discussions with their DC clients," Cerulli said in the report's executive summary.
Added Mr. O'Brien, "There seems to be a lingering confusion among plan sponsors and participants about how ESG investing works. Managers should seek to educate DC plan sponsors and intermediaries on the various methods of ESG investing and illustrate how their firm's product fits within the broader ESG landscape."