How Biden’s Veto of Anti-ESG Bill Could Affect Your Clients’ Retirement

The battle over ESG investing regulations is far from over, and advisors need to pay attention.

The debate over consideration of environmental, social and governance (ESG) issues by retirement plans has been raging at least since the Clinton administration. ESG investing allows plan managers to consider factors other than an investment’s ability to generate a profit when making investment decisions for plan participants.

The current ESG investing regulation allows pension, retirement and asset managers to invest clients’ retirement funds based on political whims and ideals — potentially jeopardizing those funds by failing to give appropriate weight to an investment option’s actual profitability.

President Joe Biden has now vetoed Congress’ bipartisan attempts to invalidate these “woke” regulations. However, the fight over ESG investing regulations is ongoing and far from over — meaning that advisors and clients should pay close attention to protect themselves.

ESG Background

ESG investing is a term given to investment strategies that consider more than an investment’s profitability when making investment decisions. Environmental factors include how a business’ operations could affect climate change and preservation of nature. Social factors involve how the business itself treats its employees and customers, as well as the standards to which it holds its suppliers. Governance factors often focus on the business’ operations, including executive pay, accounting standards and transparency.

The regulations put into place in 2020 by the Trump-era Labor Department created many roadblocks for retirement plan fiduciaries who wanted to consider these and other ESG factors when making their investment decisions. Plans could have been prohibited from making any investment in companies that focus on ESG factors when selecting “default” investments for plan participants who do not make their own investment elections.

However, in 2021, the Biden administration’s Labor Department announced that it would not enforce the 2020 regulations.

Late in 2022, Labor released a new set of regulations on the ESG issue. Those regulations took a neutral approach to ESG investment considerations. Basically, the regulations provided that it was up to the plan fiduciary to determine whether ESG factors were relevant to an investment decision — with the investment’s potential financial performance remaining the key driving consideration.

Congress then voted to repeal those regulations. In response, Biden issued his first presidential veto to keep the ESG-neutral regulations in place. The House of Representatives failed to secure the required two-thirds vote that could have overridden Biden’s veto.

What Does the Veto Mean for Investors?

Under the current regime, investment managers can consider the effects of ESG factors on financial performance when making investment decisions. Plans can also consider participants’ preferences to have access to sustainable investment options. Plans are not required to consider these factors, but they now have the option if they believe it is in the investor’s best interest.

In other words, financial performance remains the key priority, but the plan can consider how ESG factors might ultimately affect an investment’s profitability over the long term.

Proponents of ESG investing believe that by considering ESG factors, plan managers can help clients avoid the losses that can result when businesses engage in illegal, unethical or risky behavior (for example, they point to the BP oil spill or the Volkswagen emissions scandals, which cost investors billions of dollars).

Further, companies are increasingly building ESG considerations into their business models and prioritizing the well-being of their employees and the environment as a part of their overall business strategy. In the long run, these business strategies could result in more profitable companies. If plans were prohibited from sustainable investments entirely, participants could miss out on those profits.

Conclusion

The effects of the ESG investing rule — and the success of ESG investing itself — are far from clear. While the rules may change in the future, under the current regime, it seems that retirement plans ultimately will have to factor ESG issues into the equation when those factors could affect an investment’s profitability.

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