Déjà vu all over again: DOL issues guidance on ESG integration in the investment process
Last week, the US Department of Labor (DOL) announced a proposed rule to clarify its investment duties regulation. The rule is intended to provide clear regulatory guideposts for plan fiduciaries on issues involving environmental, social, and governance (ESG) investing.
This back and forth on ESG has been ongoing. Relatively permissive incorporation of ESG into the investment process was first published by the DOL in 2015. This 2015 guidance cracked the door for plan sponsors considering ESG factors, citing mounting academic evidence about ESG and the materiality of some factors in support of the DOL’s view that ESG could be additive to the investment process. In 2018, the DOL released Field Assistance Bulletin No. 2018-01, which offered additional guidance to plan fiduciaries about how ESG investing may and may not be considered in the investment process. This guidance was seen as pushing back on the earlier more permissive guidance.
Some see the DOL’s 2020 guidance as an attempt to dissuade the use of ESG factors — which seems curious at a time when more investors are including material ESG factors in their analysis.
In a statement released with the proposed regulation, Secretary of Labor Eugene Scalia says the rule is intended to provide “clear regulatory guideposts” for plan fiduciaries as ESG investing becomes increasingly entrenched in the investment process.
The proposal would make five core additions to the regulation [Note: Edited for clarity]:
- New regulatory text codifies the
DOL’s longstanding position that ERISA requires plan fiduciaries to select investments
and investment courses of action based on financial considerations relevant to
the risk-adjusted economic value of a particular investment or investment
course of action.
- An express regulatory provision states that compliance with the exclusive-purpose duty (i.e., loyalty) in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits under the plan to nonpecuniary goals.
- A new provision requires fiduciaries to consider other available investments to meet their prudence and loyalty duties under ERISA.
- The proposal acknowledges that ESG factors can be pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. The proposal adds new regulatory text on required investment analysis and documentation requirements in the rare circumstances in which fiduciaries are choosing among truly economically “indistinguishable” investments.
- A new provision on selecting designated investment alternatives for 401(k)-type plans reiterates the DOL’s view that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of an investment alternative to be offered to plan participants and beneficiaries in an individual account plan (commonly referred to as a 401(k)-type plan). The proposal describes the requirements for selecting investment alternatives for such plans that purport to pursue one or more ESG-oriented objectives in their investment mandates or that include such parameters in the fund name.
In a nutshell, the new rule says fiduciaries cannot sacrifice returns to achieve some other objective, such as societal considerations or other nonfinancial concerns.
This may limit the use of funds labeled ESG or Sustainable in ERISA plans. In cases in which fiduciaries can show that ESG integration of material ESG information is part of a fundamental investment process, which is increasingly the case, there should be no problem.
Each DOL Interpretive Bulletin on the issue of ESG has consistently stated that the paramount focus of plan fiduciaries must be the plan’s financial returns and risk to participants and beneficiaries. The disagreement between the DOL under the previous administration and the current administration echoes a question from the investment world — that is, how can ESG best be incorporated into the investment process?
CFA Institute consistently monitors key debates and evolving issues concerning the role and application of ESG information in the investment-management process. More thorough consideration of ESG factors by financial professionals can improve the fundamental analysis they undertake and ultimately the investment choices they make. In 2018, CFA Institute issued a statement on the incorporation of material ESG factors into the investment process. The full statement can be read, here.
Comments on the new DOL guidance are encouraged up to 30 days after the official publishing of the rule proposal, which should be relatively soon. CFA Institute will deliver a response.
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