Can DOL’s New Rule Revive Investors’ Confidence in ESG?

The regulation from the Department of Labor is expected to be more durable than the old one banning ESG considerations by retirement plans.

Illustration by II

Illustration by II

Plan fiduciaries investing according to environmental, social, and governance principles may be breathing a sigh of relief after the Department of Labor finalized the rule allowing retirement plans to take these factors into consideration.

This week DOL announced a rule that reversed two regulations issued under the Trump administration, which banned plan fiduciaries from investing in “non-pecuniary” instruments. The new DOL rule, called Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, allows plan fiduciaries to weigh ESG factors during the investment process and could prompt more retirement plans to consider ESG-oriented strategies.

“I think the DOL’s intent is to make plan sponsors unafraid of offering ESG strategies,” Lance Dial, partner at law firm Morgan Lewis, told Institutional Investor in an interview. One possible outcome is that more retirement plans will add ESG products, he said.

Dial expects the DOL rule to have more staying power than those proposed in earlier years. “This rule is very carefully drafted to be in the middle…It gives some consideration to both sides of this debate,” he said. “I think [the DOL did] a pretty good job of trying to find that middle road and maybe something that’s a little more durable than what we’ve had in the prior years.”

Lia Mitchell, senior policy analyst at Morningstar, agreed. “I do think that this rule is going back to the basics and highlighting the elements of fiduciary standards that plan sponsors can rely on...That might be one reason to think it will persist a little bit longer [than previous rules],” she said.

The DOL rule comes at a time when the debate over ESG investments continues to heat up. Recently, the rise of the so-called anti-woke movement has prompted Republican legislators in Florida, West Virginia, Utah, Minnesota, Louisiana, and Arizona to propose bills that could prevent state institutions from working with managers that include ESG-related factors in their investment processes.

ESG has also been caught in the crosshairs of regulators. According to a recent KPMG survey, increasing regulatory uncertainty became one of the top reasons that some managers decided to pull back on ESG. In October, a series of HSBC ads marketing ESG products were banned in the U.K. for making unqualified claims about their environmental benefits. According to the Advertising Standards Authority in the U.K., the ads “omitted material information and were therefore misleading.”

On Tuesday, Goldman Sachs Asset Management was also fined $4 million by the Securities and Exchange Commission for “several policies and procedures failures involving the ESG research its investment teams used to select and monitor securities” in three funds. “These historical matters did not materially impact the investments’ satisfaction of the ESG criteria contained in those policies and procedures,” GSAM responded in a statement.

Mitchell thinks the ESG industry is still in an “adjustment period,” where regulators in the U.S. and around the world are still trying to aid investors in navigating various ESG strategies. “Anytime there’s innovation in the financial sector, there’s a period of adjustment where everyone has to learn [about] the innovation, how it is becoming more mainstream, and how it is going to interact with other elements of the industry,” she said.

Yet despite the ongoing political debate and the SEC scrutiny, the DOL rule is good news for most retirement plan participants.

“There’s [a perception that] younger people have a more enhanced social conscience,” Dial said. “There is demand [for ESG] out there at the investor level…And so I think [the rule] gives people a tool to respond to that investor demand.”