The benefits community must prepare for new ESG investing rules

As the U.S. Department of Labor considers feedback on a proposed rule that will affect investors’ ability to consider climate risk when making decisions about nearly $8 trillion in assets, benefits brokers, money managers and retirement advisors should take this time to understand the implications and heightened expectations of their clients and constituents. With 140 million-plus Americans participating in 401(k) or other ERISA plans, it’s crucial fiduciaries look out for the best interests of their plan participants and that prudent investors consider climate risk in their investment decisions.

As part of a broader federal initiative to advance environmental justice and address climate change, the Department of Labor’s proposed rule, Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, follows President Biden’s May 2021 executive order directing all federal agencies to incorporate climate risk and other environmental, social and governance (ESG) issues into financial regulation. This comes after the announcement in March 2021 of a non-enforcement policy for the Trump-era regulations.

The Department of Labor’s proposed rule makes it clear that a plan fiduciary may “consider any factor relevant to the risk-return analysis, including climate change and other ESG factors.” However, the Trump administration’s 2020 rules, which the Biden administration’s would replace, restricts plan sponsors from considering climate and other ESG factors when selecting investments or exercising shareholder rights. Even with the non-enforcement policy in place, this chilling effect has caused fiduciaries to stop or scale back their efforts to provide investment options that address ESG concerns. As of 2019, only 3% of 401(k) plans included an ESG option, according to the Plan Sponsor Council of America, and those investments accounted for just 0.1% of plan assets. Deloitte has forecast that ESG-mandated assets could make up to half of all managed assets in the U.S. alone by 2025, but for now, investors are missing out on the potential benefits of ESG funds. Until the Department of Labor’s updated stance on ESG funds is solidified through policy, investors will continue to exercise caution when it comes to ESG considerations.

As we look ahead to establishing a more ESG-friendly ecosystem for investing, fund managers and advisors who are considering developing this area further but lack climate expertise should either train their staff or hire outside consultation. There is growing demand for ESG investing options: in 2019, 72% of the U.S. population expressed a moderate interest in sustainable investing, and despite the undersupply of ESG funds offered by ERISA plans, investors contributed $51.1 billion to sustainable funds in 2020, compared with less than $5 billion five years ago. Socially responsible investing expertise will be especially pertinent for managers interested in reaching younger generations of investors: according to the Harris Poll, one-third of Millennials often or exclusively use investments that take ESG factors into account.

As America undergoes the Great Resignation, companies may find that offering ESG investing options through their 401(k) and other retirement plans can give them a competitive edge in retaining their workforce. A recent study found nine of 10 defined contribution plan (DC) participants who are aware they have access to ESG-related investment options by their employer take advantage of them. With almost 60% of employees considering a company’s social and environmental commitments when deciding where to work, ESG investing shouldn’t be treated as an afterthought. For companies looking to hire talent in a tight labor market, the inclusion of ESG investment offerings in benefits packages may strongly appeal to would-be hires. 

Asset managers should consider launching new climate and ESG products focused on the Employee Retirement Income Security Act (ERISA) DC market. In particular there are very few such FUNDS eligible as default funds (QDIA). Additionally, plan sponsors should give more thought to how they want to exercise their shareholder rights and articulate this in their plan documents.

While the Department of Labor rule’s timeline is unclear – it is currently reviewing more than 20,000 comments from external stakeholders – it is clear this rule has potential to transform the decision-making process for millions of investors nationwide. Federal guidance will create a level of clarity that will allow American workers to make more informed investment decisions, and this waiting period is a prime opportunity for the benefits community to prepare for this significant change in policy.

Steven Rothstein is Managing Director of the Ceres Accelerator for Sustainable Capital Markets.