Proposed US Rule Would Inhibit ESG Funds As Retirement Investments

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The US Department of Labor (DOL) is speeding ahead with a proposal to make it more difficult for fiduciaries of retirement plans to direct money to ESG-focused funds. The move comes despite widespread objections from the money management industry. Indeed, an analysis of more than 8,700 public comments on the proposed US rule change limiting environmental, social, and governance investing in Employee Retirement Income Security Act of 1974 (ERISA)-governed retirement plans finds overwhelming opposition. Yet the Trump administration is forging ahead in attempts to beat the November 3 US election date and to make the rule permanent.

The Employee Benefits Security Administration submitted the US rule change, called “Financial Factors in Selecting Plan Investments,” to the White House recently. The administration’s stance is that ESG investment strategies sacrifice returns and promote goals unrelated to financial performance. It wants to adjust the Employee Retirement Income Security Act of 1974 (ERISA) to require financial institutions overseeing pension and 401(k) plans to place economic interests ahead of what’s known as non-pecuniary goals.

Partial language of this proposed US rule change states:

“The Department’s aim is to assist ERISA fiduciaries by establishing clear regulatory guideposts for plan fiduciaries in light of recent trends involving ESG investing that the Department is concerned may lead ERISA plan fiduciaries to choose investments or investment courses of action to promote environmental, social, and public policy goals unrelated to the interests of plan participants and beneficiaries in financial benefits from the plan and expose plan participants and beneficiaries to inappropriate investment risks.”

What that means is, unlike financial goals that focus on increasing profits, non-pecuniary, or non-monetary goals, focus on other aspects of finance, including how the investment helps the community. The subtext here is that ESG and green investing isn’t a valid avenue for investment houses to use to advise clients — it’s directed to help the planet and the humans who live here, rather than having a strict plan for profit.

About $20 billion flowed into ESG- and values-focused exchange-traded funds as of September 30, exceeding the calendar-year record of $9.2 billion set in 2019, as reported by Bloomberg Intelligence. Yet, as Bill McKibben notes, “Diehard libertarians (are) clinging to the Milton Friedman theory that a corporation has no social responsibility beyond making money.”

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Financial Advisors Opposed to Proposed US Rule Exclusion for ESG Retirement Funds

Usually, when US rules undergo review, a public comment period of 60 to 90 days follows. In this case, though, the DOL incorporated just a 30-day comment period on a matter of significant and growing interest to investors and retirement-plan participants and beneficiaries. Despite this unusually short comment period, the Notice of Proposed Rulemaking drew 8,737 comments, including several petition letters signed by thousands of individuals.

More than 130 fund management and financial advisory firms have written opposing the plan since it surfaced in June. They see the conditions set out under the plan as burdensome and as mechanisms that essentially ban ESGs from being designated as qualified default investment alternatives in 401(k) plans.

Jon Hale, director of ESG research for the Americas at Chicago-based Morningstar Inc., claims that the proposed rule is so “shoddily constructed” that it’s unlikely to withstand legal scrutiny. A letter sent from Morningstar objecting to the proposed US rule change includes, “Firms without a plan to cope with climate change may be caught flat-footed in the face of new regulation or environmental realities.”

“It has significant implications for the retirement savings of millions of Americans, yet the DOL saw fit to allow only the shortest possible time for comment and now seeks to finalize it before the current administration gets tossed out of office,” Hale told Bloomberg Green. “In a normal process, such overwhelming opposition would send regulators back to the drawing board.”

Hale outlines the 6 key points commenters used as they voiced opposition to the proposed US rule:

1. The proposal is not based on evidence that a problem actually exists.
2. The proposed rule largely dismisses the financial materiality of ESG issues and ignores research regarding the materiality of ESG in financial decision-making.
3. The proposed rule is based on a flawed and unsupported assumption that ESG funds give up financial returns in favor of “nonpecuniary” rewards.
4. Rather than being subjected to additions burdens and restrictions, incorporating ESG factors into investment decisions should be considered a part of fiduciary duty.
5. Excluding ESG investments from QDIAs in defined-contribution plans is inappropriate and could harm plan participants/beneficiaries.
6. Singling out ESG for a heightened level of scrutiny and restriction is inappropriate and unwarranted.

In January, BlackRock announced it will “make investment decisions with environmental sustainability as a core goal” and will “release climate disclosures for their mutual funds.” The Harvard Business Review analyzed 3000 firms between late February and late March, 2020; the data indicated that, during this tumultuous period, stocks that the public perceived as ESG responsible outperformed their competitors. Green bond performance is now starting to deliver what’s being called “greenium,” and UBS analysts said in late March that they expected green bonds to show “lower volatility and smaller drawdowns” during stressful market periods.

Yet only 65% of US investors have added ESG funds to their portfolios. That number stands in comparison to 89% in Europe, 89% in Canada, and 72% in Asia.

Senator Elizabeth Warren Weighs in on ESG Funds

Eugene Scalia is the US labor secretary. He’s also the son of the late conservative Supreme Court Justice Antonin Scalia. Scalia the younger doesn’t have a positive track record of fighting for the people or institutions he’s supposed to protect — which, in the Labor Department, is workers. Richard Trumka, president of the AFL-CIO union federation, commented that Scalia’s nomination was “insulting, it’s dangerous, and workers are not going to forget it.”

In a Wall Street Journal editorial, Senator Elizabeth Warren (D-MA) argues:

“Mr. Scalia overlooks that ESG funds routinely outperform other offerings and ignores well-documented economic risks from climate change. Unlike Mr. Scalia, investors know climate change threatens investments. Mr. Scalia even admitted, himself, investors want ESG investing, and reports predict this trend will surge. Instead of limiting ESG considerations, Mr. Scalia should call for strong ESG standards and risk disclosures, such as those in my Climate Risk Disclosure Act.”

The fossil-fuel industry has been a full-on supporter of Trump, who has called the globally-accepted science behind global warming a “hoax.” Scalia has been complicit in the Trump administration’s efforts to roll back nearly 100 environmental safeguards. These environmental deregulatory policies are already having a substantial impact on the people and habitats that experience them. The Trump actions have been cast as ways to counter the Obama-era “anti-growth” framework. Yet the Obama administration’s carefully developed rules were constructed to ease pollution, mitigate the climate crisis, and set up barriers against harmful chemicals.

Final Thoughts

Is the federal government taking the public-comment process seriously? It seems not.

If former Vice President Joe Biden wins the November 3 US presidential election in less than 2 weeks, it’s likely his administration would seek to undo this proposed US rule change. Even if a dark winter of a Trump reelection were to occur, the proposal seems destined for a court challenge. That’s because the administration may be violating the Administrative Procedure Act (APA) in the attempt to eliminate ESG funds as sources for retirement investments.