Rule-change limiting ESG retirement investments under scrutiny by asset managers

A federal rule proposal to restrict worker retirement plan investments that address environmental, social or governance (ESG) causes is under scrutiny from asset management firms who say it would place unnecessary burden on financial planners and limit opportunities for their retirement investors. 

The proposed rule, issued by the Department of Labor on June 30, would require fiduciaries of private employee retirement funds covered by the Employee Retirement Income Security Act (ERISA) to choose investments based solely on financial considerations relevant to its risk-adjusted economic value. 

Pensions and individual plans wouldn’t be able to cite “non-financial goals” to decide on investment funds, like divesting from fossil fuels and re-investing in environmentally sustainable companies, according to the proposed rule. Choosing between one investment versus another would have to be based on “economic merits of the investment,” according to the proposal.   

Department officials said in a press release that the proposal comes “in light of recent trends involving environmental, social and governance investing.” According a report by financial consulting firm Deloitte, ESG assets could grow almost three times as fast as non-ESG-mandated assets to comprise 50% of all managed assets in the U.S. by 2025. 

“Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan,” said Secretary of Labor Eugene Scalia. “Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”

Following a 30-day comment period that ended at the end of July, more than 200 asset management firms from across the country and in Pennsylvania submitted comments in near unanimous opposition to the proposal, arguing it singles-out ESG investments, without evidence of their misuse by fiduciaries, and puts arbitrary restrictions on retirement plans. 

Industry titans like BlackRock, T. Rowe Price and the Vanguard Group said the rule would limit the options of retirement investors. 

“Investors must have access to full and fair disclosure in order to make an informed investment decision,” John James, managing director of Vanguard’s Institutional Investor Group, said in the letter. “Like all investors, retirement investors need accurate information to enable them to evaluate which products align to their individual goals. Fiduciaries need accurate and comparable information to enable them to prudently select and monitor plan investments.”

The American Retirement Association said the proposal would largely constrain fiduciaries from considering ESG factors as part of a prudent process even those deemed to have a substantive impact. Given the lack of consensus around what constitutes an ESG investment, the association said prudent investment options could be excluded by a plan if an ESG label is found in marketing or disclosure materials.

“Moreover, they might feel pressed to overlook such an option, even if it were deemed to be prudent and a superior investment choice simply because ESG is incorporated in its construction and maintenance,” association officials said in their comment. 

Pennsylvania Treasurer Joseph M. Torsella said the department’s rule would narrow the field of available investments by discouraging fiduciaries from investing in ESG-guided funds, resulting in lost long-term retirement savings. Narrowing the number of available investments would also frustrate investors seeking to maximize portfolio for long-term strategies. 

“The use of nonfinancial considerations as tiebreakers has been an essential part of ERISA practice, allowing fiduciaries to take into consideration factors, including some ESG factors, but that cannot be conclusively shown on an individual basis to have a positive economic effect, but whose application does not diminish financial returns,” Torsella said. 

Interference in the investment preferences of retirement investors on political grounds rather than to fulfill ERISA’s purposes, would be “arbitrary and capricious,” Torsella said, infringing on the economic rights of those investors and a potential violation of their First Amendment rights. 

Conservative lobbying groups American Legislative Exchange Council (ALEC) and Free Enterprise Project approved of the rule change, calling for a stop to asset management strategies perceived as overtly political at the potential cost of lower investment yields. 

“ERISA fund managers owe a clear duty to maximize the value of the funds they manage, and violate their fiduciary duties if they act otherwise,” FEP Director Justin Danhof said in his comments. “This rule correctly confirms these principles that have been clearly and repletely established in statue and legal precedent.”