The Department of Labor unveiled a final rule Friday stipulating that ERISA plan fiduciaries cannot invest in “non-pecuniary” vehicles that sacrifice investment returns or take on additional risk, though the final rule focused less on ESG than the proposal on which it was based.
The rule was proposed in June and drew harsh criticism from the retirement community, including claims that the Labor Department did not sufficiently justify its reasoning behind the proposal and concerns that 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.
Chiefly, the final rule requires ERISA plan fiduciaries to select investments based on pecuniary factors, described as any factor that a fiduciary prudently determines is expected to have a material effect on the risk and return based on appropriate investment guideline.
“Retirement plan fiduciaries may never sacrifice investment, take on additional risk or increase cost in order to promote goals unrelated to the financial interests of their plan participants,” said Jeanne Klinefelter Wilson, acting assistant secretary of Labor for the Employee Benefits Security Administration, during a call with reporters Friday. “Now, this does not mean that fiduciaries are prohibited from considering such issues as environment impact and workplace practices when they are relevant to the financial analysis. Because these issues are pecuniary in that instance, and therefore appropriate considerations under the rule.”
On the same call, a senior Labor Department official noted that “ESG” is not mentioned anywhere in the rule text, though it is mentioned extensively in the preamble. “The focus on the final rule is on whether a factor is pecuniary, not whether it’s an ESG factor,” the official said.
In a fact sheet, EBSA said it concluded “that the lack of a precise or generally accepted definition of ‘ESG,’ either collectively or separately as ‘E, S and G,’ made ESG terminology not appropriate as a regulatory standard.”
Several changes were made from the proposal to the final rule, including a specification that fiduciaries only need to consider “reasonably available alternatives with similar risks” in order to meet their prudence and loyalty duties under ERISA, the senior Labor Department official said. The official noted that fiduciaries do not have to consider “an infinite number of alternatives,” which was a concern expressed in comment letters.
Another change in the final rule concerns qualified default investment alternatives, or QDIAs. The proposal contained a blanket prohibition on any fund that used ESG factors from being used in a qualified default investment alternative, even if those factors were used for pecuniary purposes. However, the final rule only excludes a fund from being a QDIA if its investment objectives, goals or principle investment strategy include or consider the use of one or more non-pecuniary factors.
George Michael Gerstein, co-chairman of the fiduciary governance group at Stradley Ronon Stevens & Young, said it’s unclear whether the Labor Department’s actions will be enough to give people comfort in adding a QDIA that has an ESG strategy. “The final rule opens the door to that, but it’s a narrow opening.”
Steven Rothstein, managing director of the Ceres Accelerator for sustainable capital markets, said the final rule will likely have a “chilling effect” on ESG investing. “This is a very a harmful action by the Trump administration at a time when global climate crisis looms large and is affecting everyone’s lives,” he said. “Today’s decision is really unwelcome by pension fund investors and other fiduciaries and truly runs counter to global trends,” he added, referencing the recent uptick in ESG investing in the U.S.
Data from Morningstar show a nearly fourfold increase in 2019 over the previous year in flows into U.S. sustainable funds, at $21.4 billion.
The entire rule-making process lasted a bit over four months, including a 30-day comment period during which more than 1,100 comment letters were filed, mostly in opposition. Typically, rule-makings take significantly longer, even years.
But Mr. Gerstein said it makes sense for an administration to work quickly in the lead up to an election. “We’re in the fourth quarter of the first term of this administration ... they’re looking at the clock carefully,” he said. “So I’m not at all surprised that they moved quickly with this.”
The rule will be effective 60 days after publication in the Federal Register, but plans will have until April 30, 2022, to make any changes to certain QDIAs, where necessary to comply with the final rule, the Labor Department noted.