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DOL Greenlights Broader ESG Use in 401(k) Plans

By John Manganaro

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What You Need to Know

  • The final regulation represents a key step forward in a decades-long regulatory saga.
  • Under the final rule, retirement plan fiduciaries have greater leeway to consider ESG issues while selecting investment options for participants.
  • Court challenges and future regulatory reversals remain possible.

On Tuesday, the U.S. Department of Labor published a final regulation aimed at easing the concerns of retirement plan fiduciaries as they review, select and maintain ESG-focused investments within employer sponsored retirement plans.

According to a DOL statement, the purpose of the final regulation is to better allow plan fiduciaries to consider climate change and other environmental, social and governance factors when they select retirement investments and exercise shareholder rights, such as proxy voting.

In the statement, Secretary of Labor Marty Walsh says the final regulation has been developed through extensive consultations and feedback from a wide range of stakeholders. He says the public and industry feedback received by the DOL allowed it to concluded that two related rules issued in 2020 during the prior administration “unnecessarily restrained” plan fiduciaries’ ability to weigh such ESG factors when choosing investments — even when those factors would benefit plan participants financially.

The rule is formally titled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” In the DOL statement, Lisa Gomez, the recently confirmed head of the Employee Benefits Security Administration, says the rule will end the chilling effect created by the prior administration on considering ESG factors in retirement plan investments.

“Climate change and other environmental, social and governance factors can be useful for plan investors as they make decisions about how to best grow and protect the retirement savings of America’s workers,” she says.

The rule will be effective 60 days after its publication in the Federal Register. Certain proxy voting provisions of the rule, however, come with delayed applicability to allow fiduciaries and investment managers additional time to prepare.

Tuesday’s publication of the final regulation comes at a time when ESG investing is both growing in global popularity and becoming more of a political issue for some U.S. conservatives. Back in August, for example, Gov. Ron DeSantis of Florida moved to ban state pension funds from screening for ESG risks, while Texas banned BlackRock Inc., UBS Group AG and eight other finance firms from working with the state after finding them to be hostile to the energy industry.

In a statement sent to ThinkAdvisor in the wake of the rule’s publication, As You Sow CEO Andrew Behar celebrated the development, noting that his firm is dedicated to helping investors understand their portfolios’ exposure to key ESG risks and issues.

Behar says the new rule appropriately codifies ESG as a framework for assessing risk — not a means of injecting politics in investment practices.

“This is a core tenet of fiduciary duty and enables plan fiduciaries to act in their beneficiaries’ best interests to consider and minimize portfolio risk,” Behar says. “Ignoring climate change, racial injustice, abuse of worker’s rights and poor governance in employees’ retirement assets doesn’t make that risk go away.”

Andy Banducci, senior vice president of retirement and compensation policy at the ERISA Industry Committee, also shared a statement celebrating the DOL’s final rule. He notes that the ERISA Industry Committee has long urged regulators to provide retirement plan fiduciaries with clear and consistent rules on retirement plan investment selection.

“We warned DOL last year that its proposal threatened to create confusion by unduly emphasizing specific factors for fiduciaries to consider, by creating an unnecessary tiebreaker rule, and by leaving significant operational questions unanswered,” Banducci writes.

According to Banducci, the new final regulations partially respond to these concerns, in that the DOL has clarified that the final rule does not establish a mandate to consider any specific factor in every circumstance or put a thumb on the scale when selecting investments.

“While DOL retained the proposal’s confusing tiebreaker rule, it removed an unnecessary and burdensome documentation requirement,” Banducci says. “We are continuing to review this complex final regulation with our member companies and will urge DOL to further clarify and provide flexibility as necessary.”

Lazaro Tiant, sustainability investment director at Schroders, tells ThinkAdvisor his firm continues processing the details of the finalized ruling, but he is pleased to see that the spirit of the initial proposed guidance has remained consistent in its final form.

“We recognize that the DOL considered a significant number of comments, and we feel that they were able to make the appropriate adjustments to provide further clarity,” Tiant says. “There are also new details in the rule, such as a provision that allows for the consideration of participant preferences, highlighting a potentially significant change for retirement plans going forward.”

Overall, Tiant says, understanding the nuances of ESG-related factors helps give investors a fuller perspective of risk and return, and the firm looks forward to working with retirement plans on providing education to support their efforts to put the provisions of the new rule into practice.

John Manganaro

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