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Portfolio > Portfolio Construction > ESG

DOL Plan to Limit ESG in 401(k)s Draws Growing Opposition

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Opposition to the Labor Department’s proposal to limit environmental, social and governance focused investments in 401(k) plans is growing, along with requests for a longer comment period.

Morningstar, Heartland Capital Strategies, Principles for Responsible Investment and Institutional Shareholder Services (ISS) have written comment letters opposing the proposal along with 41 Democratic members of the House, 13 Democratic members of the Senate and others. 

In addition, a coalition of trade groups representing financial institutions with business in the defined contribution space are asking Labor for a 30-day extension to the public comment period on the proposal that is scheduled to end on July 30. They include the American Bankers Association, the Securities Industry and Financial Markets Association, the Insured Retirement Institute,  the Investment Company Institute, the Defined Contribution Institutional Investment Association, the Investment Adviser Association and the SPARK Institute.

“The changes described in the proposal are significant and demand comprehensive review in order to properly consider their impact on plan investments and current practices,” reads their letter to the Employee Benefits Security Administration, the division that oversees retirement plans. “To help avoid unintended consequences that could include increased costs and burdens on fiduciaries for the selection of any plan investment, significant limitations on the investment choices of plan participants, and increased risk of litigation against plans, more than thirty days is need for analysis.”

The House Democrats who wrote to the department are asking that the comment period be extended for an additional 60 days.

Unusually Short Comment Period

The Labor’s 30-day comment period on its proposal to limit investments based on consideration of ESG factors for DC plans is unusually short but not unprecedented. The department’s recent fiduciary rule proposal designed to align with the SEC’s also has a 30-day comment period (ending Aug. 6) and has also been criticized by Democrats in Congress and public interest groups.

(Related: Short DOL Fiduciary Rule Comment Period Faces Criticism)

Both proposals have been developed under leadership of Labor Secretary Eugene Scalia, the agency’s head since September and son of the late Supreme Court Justice Antonin Scalia.

The DOL proposal on ESG-focused investments reverses earlier guidance from the agency under the Obama administration, which allowed retirement plans operating under the Employee Retirement Income Security Act to consider the social impact of their investments so long as those investments didn’t compromise fiduciary obligations.

The Proposal 

The latest proposal states that ERISA plan fiduciaries may not invest in ESG vehicles if the investment strategy subordinates returns or increases risk “for the purpose of non-financial objectives,” according to a statement from the Labor Department.

(Related: DOL Proposes Limit on ESG Investments in Retirement Plans)

The proposal would not ban ESG considerations for investments in defined contribution plans but would require that fiduciaries pursue ESG-focused investments only if they are “economically indistinguishable” from non-ESG investments and document through “proper analysis and evaluation” why an ESG-focused investment was used if it was selected based on a non-monetary — the department uses the term “non-pecuniary” — factor.

ESG factors may only be considered if they “present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories,” according to the department.

In addition, the proposal would prohibit the use of ESG-oriented fund options as a DC plan’s qualified default investment alternative, which serves as the default investment option in plans when participants don’t make the choice themselves. 

The Opposition Arguments

Opposition to the DOL proposal revolves around several arguments:.

  • Its negative impact on investors. Limiting ESG investments could increase risks and costs of plans, threaten performance and discourage plan participation by those who want to match investments to their values
  • Inconsistency with other DOL rules because it singles out one type of investment focus when it doesn’t do the same for others
  • Burden for plan sponsors, which could discourage their use of ESG-focused investments, causing “even worse outcomes for plan participants,” according to Morningstar.
  • An outdated understanding of the role that ESG factors play in the current investment environment.

“ESG risk analysis should be part of any prudential investment analysis — not called out for special unique scrutiny,” note Morningstar analysts who penned the firm’s comment: Brock Johnson, president of its retirement services; Aron Szapiro, head of policy research; Jon Hale, head of sustainability research; and Michael Jantzi, CEO of Sustainalytics, a sustainable investing research firm that Morningstar has purchased. “ESG-focused funds have generally outperformed conventional fund peers, over the past one-, three-and five-year periods.” 

Heartland Capital’s Marketing Committee Co-Chair David Keto calls the Labor proposal “arbitrary and capricious,” noting it could end up “forcing participation into potentially lower-performing investments resulting in lost, long-term retirement savings, in direct contravention of ERISA’s purpose.” He notes the growing popularity of the ESG approach to investing among major asset managers like BlackRock and investors, affecting $12 trillion in U.S. investment assets, according to US SIF.

As such, the DOL proposal “reflects an outdated understanding of the importance of ESG integration,” according to Fiona Reynolds, CEO of the Principles for Responsible Investment, which represents more than 3,000 investors with over $100 trillion in assets.

And “at a pivotal moment in the fight against systemic racism,” the proposal would undermine efforts by investors to support “inclusion and diversity in corporate culture from the board to the workforce,” according to the 13 Democratic senators that signed a comment letter.

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