Industry Update: DOL on ESG Barriers
DOL ANNOUNCES FINAL RULE TO REMOVE BARRIERS TO
CONSIDERING ESG FACTORS IN PLAN INVESTMENTS
SUMMARY
The U.S. Department of Labor (DOL) announced a final rule that allows plan fiduciaries to consider climate change and other environmental, social and governance (ESG) factors when they select retirement investments and exercise shareholder rights, such as proxy voting. This final ruling will add and remove regulatory text to ERISA’s fiduciary duties to clarify that ESG factors may be considered in making prudent investment decisions. The final rule retains the core principals of the duties of prudence and loyalty and only removes text added in the 2020 final rule. The final rule addresses five sections of ERISA’S fiduciary duties and is expected to become effective January 30, 2023.
KEY TAKEAWAYS FROM THE FINAL RULE
Changes to Clarify Permissibility of Consideration of ESG Factors
Addition of regulatory text under Investment Duties, clarifying that fiduciaries may consider the economic effects of climate change and other ESG factors as part of a prudent risk return analysis when selecting investments. The final rule also removes the terminology of “pecuniary/non-pecuniary”.
Changes to Qualified Default Investment Alternative (QDIA) Provisions
Removes the special rules for QDIAs that applied under the 2020 rules. As a result, fiduciaries may consider QDIAs that have ESG strategies, and the standards applied to QDIAs are no different than those applied to all other investments.
Changes to Clarify the Application of the Duty of Loyalty (The Tiebreaker Test)
Replaces provisions in the 2020 rules requiring competing investments be economically indistinguishable before considering collateral factors to break a tie and imposed a special documentation requirement on the use of collateral factors.
The new standard instead requires the fiduciary to prudently conclude that competing investments equally serve the financial interest of the plan before considering collateral factors and removes the provision of special documentation. Collateral factors meaning benefits other than investment returns.
Addition of Investment Alternatives in Participant Directed Plans
Fiduciaries do not violate their duty of loyalty solely because they take participants' non-financial preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans.
Provisions on Shareholder Rights including Proxy Voting (Shares of Stock)
Elimination of specific requirements for proxy voting, the DOL is trying to encourage fiduciaries to vote on behalf of their participants where previous verbiage was seen to encourage abstention.
OUR TAKE
The DOL has periodically considered how ERISA's fiduciary duties of prudence and loyalty apply to plan investments that promote ESG goals. Climate change and social governance are hot political topics, each administration’s tone and guidance varies so these rules may change in the next administration. However, the DOL’s guidance has been consistent with not prohibiting ESG considerations in investment selection. The main theme with these new amendments is furthering the concept of not prohibiting ESG considerations, but also not letting them be the sole decision factor. Therefore, fiduciaries may consider investments with ESG strategies but should evaluate them with the same risk/return standards as any other investment.
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SOURCES: Department of Labor: US DEPARTMENT OF LABOR ANNOUNCES FINAL RULE TO REMOVE BARRIERS TO CONSIDERING ENVIRONMENTAL, SOCIAL, GOVERNANCE FACTORS IN PLAN INVESTMENTS Department of Labor: Final Rule on Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights