The U.S. Labor Department has finalized a rule that gives fiduciaries of retirement plans the right to consider environmental, social and governance, or ESG, risks as they make investment and proxy voting decisions.
The Nov. 22 rule officially rolls back a controversial 2020 Trump administration rule that prohibited retirement plan managers from considering anything but financial factors when making investments. The 2020 rule, which went into effect shortly before Joe Biden was sworn in as president in January 2021, was never enforced.
The new rule comes as the financial services sector and U.S. industry as a whole face new directives on how to report and account for climate risks, and amid a backlash from Republican-led states that have kicked investment firms with ESG policies from their state pension and treasury funds.
The U.S. Securities and Exchange Commission's soon-to-be-released regulations requiring publicly traded companies to disclose greenhouse gas emissions and other climate risks is the highest-profile federal effort on the issue so far. Some House Republicans have pledged to fight such initiatives in 2023; the party's new majority since the midterm election will enable this.
The new Labor Department rule immediately drew comment from the ranking member of the U.S. House Committee on Financial Services, Patrick McHenry. The North Carolina Republican will likely become the committee's chair in the next Congress.
"In Biden's economy, Americans' retirement savings have plummeted," McHenry tweeted. "This is yet another example of the Biden administration and Democrats encouraging woke corporations at the expense of everyday Americans saving for their future."
Retirement assets declined 14% during the first two quarters of 2022 as the overall stock market lost value, data from the Investment Company Institute shows. Meanwhile, the S&P Global 500 ESG Index was down 15% Nov. 22 from a year ago, reflecting a weakening of technology stocks that dominate such funds, as well as the downturn of the broader market.
But recent reports by institutions such as Deutsche Bank, Morningstar and PwC suggest that investors are not dropping ESG requirements. Sustainability-focused investment strategies will continue to expand in the mid- and long term, they predict.
Fiduciaries take a long look
U.S. and European banks with ESG products could see annual revenue grow 10% by the end of the decade, new research by the consultancy Alvarez & Marsal showed.
"Yeah, the markets are down this year, but you can't just look at a snapshot in time," Andrew Behar, CEO of the investor advocacy group As You Sow, said in an interview. "People who are investing for their retirement are in it for the long-term."
The Labor Department's new rule under the Employee Retirement Income Security Act, or ERISA, removes any uncertainty over whether pension plan managers can invest in companies with ESG labels, Behar said.
"Now ERISA is saying not only that you can, but that you really should consider it," Behar said. "The number one reason that 401(k)[pension fund] managers have been saying they can't change their investment strategies is 'ERISA won't let me do it.' Now that excuse is gone."
The new rule says that "fiduciaries may, and often should, depending on the investment under consideration, consider the economic effects of climate change and other ESG factors on the investment at issue." The change goes into effect in 60 days' time.
The Labor Department received nearly 900 comments and more than 20,000 petitions, many from ERISA fiduciaries, weighing in on the rule as it was first proposed. The Sierra Club, an environmental organization, said it helped coordinate "thousands of public comments" urging the agency to go even further and require fund managers to consider climate risks.
The new rule follows a May 2021 presidential executive order directing federal agencies to advance and clarify climate change-related financial risks. Since then, agencies including the Federal Reserve Board and the Office of the Comptroller of the Currency have been considering how to account for the threat of climate change in their financial policies.
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