Labor Department digging into what action to take with ESG

The Department of Labor under the Biden administration has made environmental, social and governance investing a key focus during its first year-plus in office and is now seeking public input on a wide array of questions around climate change and retirement savings that could lead to further guidance or requirements, industry sources said.

Following a May 2021 executive order from President Joe Biden that directed federal agencies to assess and mitigate financial risks related to climate change, the Labor Department's Employee Benefits Security Administration issued a request for information last month asking the public what it should do to "protect retirement savings and pensions from risks associated with changes in climate."

The RFI comes after the Labor Department in October unveiled a proposed rule — called "Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights" — that makes clear "that climate change and other ESG factors are often material and that in many instances fiduciaries … should consider climate change and other ESG factors in the assessment of investment risks and returns."

The executive order on which the RFI is based calls on the Labor Department to identify actions it can take under the Employee Retirement Income Security Act of 1974 and the Federal Employees' Retirement System Act of 1986 to mitigate climate risks.

The RFI includes 22 questions that delve into a range of topics, from data collection: should EBSA use Form 5500 annual returns/reports to collect data on climate-related financial risk to pension plans?; to lifetime income products: do any guaranteed lifetime income products (e.g., annuities) help individuals efficiently mitigate the effects of at least some climate-related financial risk?; to oversight of the $780.6 billion Thrift Savings Plan, Washington: what actions, if any, should the TSP's asset managers take to incorporate climate-related financial risk, consistent with FERSA's terms and their duty of prudence?

"The questions are comprehensive, and it's clear the DOL is asking for genuine feedback about how investors can protect retirees," said Gregory Hershman, Washington-based head of U.S. policy at Principles for Responsible Investment, a United Nations-supported network of investors that works to promote sustainable investment. "Rather than saying, 'We want to consider ESG for the sake of considering ESG,' they're actually thinking about this practically: 'What are the risks here, and how can we make sure that retirees are protected?' I think that's a great lens for them to start this conversation."

Will Hansen, Arlington, Va.-based executive director of the Plan Sponsor Council of America and chief government affairs officer at the American Retirement Association, is concerned that the Labor Department could require plan sponsors to disclose their analysis of environmental factors on a Form 5500.

"Any attempt to make that information available on a publicly available form is then opening up the plan sponsors to future litigation," Mr. Hansen said. "I do have concerns that mandating any sort of new information on a Form 5500 that could be subjective is going to create a whole new era of frivolous litigation against plan sponsors."

Currently, there's no formal definition of terms such as "environmental factors" or "ESG," Mr. Hansen added, and attempts to standardize those terms "could backfire" in the future.

"Typically, when there's any sort of prescribed rules, you can see plan sponsors will go to the lowest common denominator to satisfy that rule, and I can see that occurring if specific information is asked of plan sponsors to be included on a Form 5500," he added.

In issuing the RFI, which has a 90-day comment period that ends May 16, the Labor Department stipulated that it's a separate initiative from the proposed ESG and proxy rule.

What the Labor Department will do with the feedback it receives is uncertain, but it could provide parameters regarding what plan fiduciaries should think about when considering ESG investments, said Bradford P. Campbell, a Washington-based partner at law firm Faegre Drinker Biddle & Reath LLP and former assistant secretary of labor for EBSA during President George W. Bush's administration.

The Labor Department in its RFI posed several questions on the Federal Employees' Retirement System Act of 1986; the Federal Retirement Thrift Investment Board; and the Thrift Savings Plan, the retirement system for 6.5 million federal employees and members of the uniformed services.

Referencing a 2021 Government Accountability Office report that said the Thrift board, which administers the TSP, "has not taken steps to assess the risks to TSP's investments from climate change as part of its process for evaluating investment options," the Labor Department asked what data, if any, should the Thrift board collect on TSP's exposure to climate-related financial risk. The DOL also asked what types of data, if any, should it collect from asset managers regarding climate-related financial risk.

Mr. Campbell noted that the Labor Department has oversight authority with respect to the TSP, but it does not have enforcement or policymaking authority.

Kim Weaver, the Thrift board's director of external affairs, said in an email that the board is reviewing the RFI but has no further comment at this time.

While the RFI's comment period is open, the Labor Department is crafting a final ESG and proxy rule that was first proposed in October.

In 2020, under the Trump administration, the Labor Department finalized two rules — one called "Financial Factors in Selecting Plan Investments," which stipulated that ERISA plan fiduciaries cannot invest in "non-pecuniary" vehicles that sacrifice investment returns or take on additional risk; and the other, "Fiduciary Duties Regarding Proxy Voting and Shareholder Rights," which outlined the process a fiduciary must undertake when making decisions on casting a proxy vote. Both rules drew sharp criticism from the plan sponsor and sustainable investing community and in 2021, the Labor Department under the Biden administration said it would not enforce either of the Trump administration's rules.

The financial factors rule, often referred to as the "ESG rule" because the initial proposal focused on ESG investment factors, excluded a fund from being a qualified default investment alternative if its investment objectives, goals or principal investment strategy include or consider the use of one or more non-pecuniary factors. It was finalized in November 2020 and took effect Jan. 12, 2021, just days before the Biden administration took office. Mr. Biden signed an executive order on his first day in office ordering a review of the rule.

The Labor Department proposal unveiled in October would allow an ESG fund to be considered a QDIA. The proposal was mostly supported by institutions during a comment period that ended in December.

"We're happy with what they proposed, and we're hopeful that the final rule will come out as strong as it can be," said Bryan McGannon, Washington-based director of policy and programs at US SIF: The Forum for Sustainable and Responsible Investment, a non-profit organization whose members represent $5 trillion in assets under management.

Faegre Drinker's Mr. Campbell expects the final rule to be substantially similar to the proposal but include some changes. "My hope is that one of those changes is they make the language a little more neutral so that really the authority to make ESG decisions resides with the fiduciaries as it should and as it does for any other relevant factor," he said.

Elizabeth S. Goldberg, a Pittsburgh-based partner with law firm Morgan, Lewis & Bockius LLP, had a similar thought. If the proposal is finalized as is, "it's a pretty material shift because it's the difference between 'ESG can be relevant' to 'ESG has to be relevant,'" she said. "I think we'll see a little bit of a walking back on that."

PSCA's Mr. Hansen said the proposal may have "gone too far in requiring a plan sponsor to offer an ESG fund, and our hope is that we kind of go back to the pre-Trump rule and that a plan sponsor is not limited in providing an ESG fund or required to offer an ESG fund."