The DOL’s proposed Rulemaking on “Financial Factors in Selecting Plan Investments” for ERISA plans is considering amendments to the “Investment duties” regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA), to confirm that ERISA requires plan fiduciaries (i.e. the investment advisors) to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.
Title I of the Employee Retirement Income Security Act of 1974 (ERISA) establishes minimum standards that govern the operation of private-sector employee benefit plans, including fiduciary responsibility rules. Section 404 of ERISA, in part, requires that plan fiduciaries act prudently and diversify plan investments so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. Sections 403(c) and 404(a) also require fiduciaries to act solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of providing benefits to their participants and beneficiaries and defraying reasonable expenses of administering the plan.
The new rulemaking is threatening to prevent plan fiduciaries from recommending or even considering ESG factors in recommending appropriate investments for beneficiaries. Advising ERISA plans is already a fairly restricted activity but demand for ESG options has steadily grown as documented in the extensive background summary provided for that rulemaking:
Available research and data show a steady upward trend in use of the term ESG among institutional asset managers, an increase in the array of ESG-focused investment vehicles available, a proliferation of ESG metrics, services, and ratings offered by third-party service providers, and an increase in asset flows into ESG funds. This trend has been underway for many years, but recent studies indicate the trajectory is accelerating. For example, according to Morningstar, the amount of assets invested in so-called sustainable funds in 2019 was nearly four times larger than in 2018.
In response to the Department of Labor’s proposed Rulemaking on “Financial Factors in Selecting Plan Investments” for ERISA plans, the DOL opened a public comment period and we submitted a comment in opposition to the proposed rulemaking. While we agree entirely that a plan fiduciary owes a single-minded focus on the interests of beneficiaries and that they need to not be distracted by “non-pecuniary” benefits when selecting investments that provide the best risk and return profiles for the beneficiaries, we totally disagree that evaluation of environmental, social and/or governance (ESG) factors are “non-pecuniary.” The evaluation of ESG performance enables greater detail of factors than clearly affect financial performance, i.e. “pecuniary” performance. We believe these additional performance metrics help fiduciaries gather more and better information about the long-term performance and prospects of companies and enable better selections and investment returns.
In fact, as shown in the below chart detailing three examples of traditional ETFs and their ESG counterparts (produced by the non-profit, As You Sow) funds that integrate ESG factors into their plans largely outperform their traditional counterparts, indicating that ESG factors can indeed be quite material and have measurable impact on investment performance, rather than, as suggested by the DOL, be a non-pecuniary factor.
As As You Sow explains: “Out of the 24 instances of comparison between traditional ETFs and their fossil-free ESG counterparts, ESG ETFs outperformed traditional ETFs 21 out of 24 times, or 88% of the time in the examples above. Not only do the ESG funds outperform their counterparts, they foster societal benefits, creating a win-win scenario for investors who are interested in investing their values with ESG.”
We further appreciate the DOL’s concerns that the current state of play for ESG funds is rather chaoic:
As ESG investing has increased, it has engendered important and substantial questions and inconsistencies, with numerous observers identifying a lack of precision and rigor in the ESG investment marketplace. There is no consensus about what constitutes a genuine ESG investment, and ESG rating systems are often vague and inconsistent, despite featuring prominently in marketing efforts. Moreover, ESG funds often come with higher fees, because additional investigation and monitoring are necessary to assess an investment from an ESG perspective.
These accusations are largely true, yet the world is changing and our understandings of how businesses must operate in order to both remain profitable, attract customers, protect employees, sustain supply chains and reward investors without degrading the planet paves the way for individual companies but also the market in general to being able to continue operating over the long term. It was less than a year ago that 181 members of The Business Roundtable, led by Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co. and Chairman of Business Roundtable, released a new Statement on the Purpose of a Corporation, committing their organizations to work for the benefit of all stakeholders — customers, employees, suppliers and communities, as well as shareholders.“Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term,” said Jamie Dimon. “These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.”
ESG investing today is substantially different from the old-style SRI investing, which sought to apply investor values to create negative screens for businesses such as tobacco, alcohol and arms manufacturers. This may explain why today the DOL seems to confuse ESG factors with what it calls “economically targeted investments” or ETIs. ESG is less like a specifically targeted negative screen and instead encompasses a broader assessment of integral business practices that reflect more enlightened understanding about business. Yes, ESG may still be at any early stage of development and data collection but efforts are underway to standardize ESG reporting and harmonize comparisons to make it both easier to work with and more effective as an evaluative tool. The DOL would better serve the beneficiaries of ERISA plans if they recognized that using ESG factors, even at this rough stage, adds to the total information about investments, increases the beneficial expertise provided by fiduciaries and will result in better outcomes for ERISA retirees as well as the markets in general. Instead of banning their use, they should evaluate how to help get companies to report on ESG factors and, in that way, support the Task Force on Climate-related Financial Disclosure‘s (TCFD) efforts to standardize and improve ESG data.
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