A US Department of Labor proposal to bar retirement plan administrators from considering environmental, social and corporate governance (ESG) factors when choosing investments could have a significant effect on the renewable energy sector.

More than 1,500 comment letters were submitted by the July 30 comment deadline. The overwhelming majority were strongly opposed to the new regulation.

The regulation is expected to be reissued in final form by year end.

The results of the November elections are expected ultimately to affect whether the regulation is implemented.

Administrative Burden

Retirement plan fiduciaries have a duty under section 414 of ERISA to act prudently and solely in the interest of plan participants and beneficiaries. ERISA is a 1974 law that establishes minimum standards for private-sector pension plans.

The proposed regulation would prohibit plan fiduciaries from considering ESG factors, or investing in funds set up to make ESG investments, if the effect is to subordinate return or increase risk for the purpose of pursuing a non-financial goal.

It would require plan fiduciaries to consider other investment alternatives, document decisions where an ESG investment is chosen, and refrain from designating an ESG fund or fund pocket as the default investment where a plan participant does not choose an alternative.

If finalized in its proposed form, the additional due diligence, process and documentation requirements are expected to discourage retirement plan investments in ESG vehicles.

The potential impact on investment in renewable energy could be significant.

At the end of the first quarter of 2020, total US retirement plan assets exceeded $28 trillion. Assets invested in sustainable funds increased fourfold from 2018 to 2019. As more millennials and other generally social-conscious investors add to their retirement savings, interest in ESG investments is expected to increase exponentially.

Past Government Positions

The Department of Labor proposed the new regulation in late June.

President Trump directed the Department of Labor in Executive Order 13868 in April 2019 to review trends with respect to retirement plan investment in the energy sector.

The proposal follows on the heels of other recent government efforts related to ESG investments.

The Securities and Exchange Commission added ESG investments to a list of 2020 examination priorities. The SEC is interested in the accuracy and adequacy of disclosure by registered investment advisors marketing new or emerging investment (including ESG) strategies.

The Department of Labor stepped up its fiduciary enforcement efforts by sending letters in May to plan sponsors, asset managers and other plan fiduciaries requesting information on what factors plans consider when investing in ESG vehicles.

The government's view of ESG investments has changed from time to time, largely mirroring changes in the political landscape.

The Department of Labor issued its first interpretive guidance on economically targeted investments (ETIs) — which is the department's term for socially responsible investments or investments using ESG criteria — during the Clinton administration in 1994. The initial standards were in Interpretive Bulletin 94-01.

The initial guidance recognized that ETI investments were not inherently incompatible with ERISA and that, plan fiduciaries may use non-pecuniary factors as a deciding factor when choosing among competing investments that serve the plan's economic interests equally well. The "all-things-being-equal" or "tie-breaker" test has served as the cornerstone for retirement plan investments in ETIs and ESG for more than 25 years.

The Department of Labor scaled back the ESG guidance during the Bush administration in Interpretive Bulletin 2008-01 in 2008. It broadened the ESG guidance during the Obama administration in Interpretive Bulletin 2015-01 in 2015 after concluding that the 2008 guidance had unduly discouraged fiduciaries from considering ETIs and ESG factors.

After President Trump was elected, the department once again scaled back the ESG guidance by clarifying in Field Assistance Bulletin 2018-01 in 2018 that plan administrators should take into account as financial factors, when making investments, whether ESG issues present material risks or opportunities to company business plans.

Consistent with 2018 guidance, the proposed new regulation recognizes that certain factors such as a company's improper disposal of hazardous waste or dysfunctional corporate governance may present a pecuniary risk that may be considered. However, it would go further than the 2018 guidance by requiring that a plan fiduciary focus only on pecuniary factors and it would prohibit a plan fiduciary from sacrificing return or accepting additional risk by promoting a public policy, political or any other non-pecuniary goal. Although it would retain the "all-things-being-equal" or "tie-breaker" test in concept, the department said in June that it "expects that true ties rarely, if ever, occur," which would render the tie-breaker test effectively unavailing.

Blowback

The number of comments received about the proposed new regulation by the July 30 deadline set a near record for comments about Department of Labor initiatives.

The majority of comments were that there is no evidence that retirement plan fiduciaries are misusing ESG factors when considering what investments to make.

Diplomacy may have gone out of fashion in the current era. For example, one letter writer called the proposed regulation an "unprecedented, unnecessary, and dangerous reversal" of policy. Another said it is unnecessary, based on "a woefully incorrect understanding of investing knowledge and theory, an endangerment to the retirement security of Americans, internally inconsistent, applying an inadequate analysis of ERISA fiduciary law and a violation of federal cost-benefit regulations." Another said it is "out of step" with the best practices that asset managers and financial advisers currently use to integrate ESG considerations into their plans.

Others asked the department to move in the opposite direction by encouraging ESG to play a role in choosing investments. For example, the American Council on Renewable Energy (ACORE) letter said the following:

If the proposed rule had the effect of chilling or reducing ESG investment, it would harm American's global competitiveness by allowing foreign investors to earn comparatively higher rates of returns . . . . [T]he Department should modify the proposed rule to clarify that ERISA's fiduciary duties compel qualified investments professionals to consider ESG investment principles as economic considerations under generally accepted investment theories.

Some comment letters challenged the view that the new regulation would not impose additional burdens on plan administrators who choose to make ESG investments. The letters said the increased burdens associated with additional due diligence, revisions to investment policies, investment advisory and management agreements and other documentation have not been considered.

The issue has become yet another source of partisan division in Washington.

Twenty-one members of the House Committee on Education and Labor submitted a letter calling the proposed rule "a solution in search of a problem" and urging the department to withdraw the proposal.

The Republican committee members said in a separate comment letter that "[u]nder ERISA, a . . . duty of loyalty prohibits [a pension plan fiduciary] from prioritizing political agendas or social policy preferences over the financial security of American workers."

Others want the department to extend the comment period. The AFL-CIO and other unions asked for an extension of 120 days to give workers more time to have their voices heard.

Some groups said they support the new regulation, citing the need for greater measures to ensure that retirement plan fiduciaries do not invest in ESG funds that charge unreasonably higher fees or place non-financial goals ahead of pension plan returns or safety.

Timetable

The new regulation will not become binding until it is reissued in final form.

Many believe that President Trump will try to reissue it as a final regulation by year end. It would be harder for any new administration to reverse a final regulation than one that is merely proposed if there is a change in administrations after the November elections. Any new administration would not take office until late January.