DOL Proposes Rule to Remove Barriers to ESG Funds in Retirement Plans

The U.S. Department of Labor (DOL) has proposed removing barriers put in place by the prior administration that would have limited plan fiduciaries’ ability to consider climate change and other environmental, social and governance (ESG) issues as risk factors affecting workers’ financial security when fiduciaries select retirement plan investments and exercise shareholder proxy voting rights.

The proposed rule,
Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, would apply to investments included in 401(k) and other defined contribution plans, as well as to defined benefit pension plans. The proposal, published in the
Federal Register on Oct. 14, follows an executive order signed in May by President Joe Biden directing the federal government
to treat climate change as a threat to workers’ retirement savings.

In 2020, the administration of former President Donald Trump had
issued a final rule, subsequently blocked by the Biden administration, that would have required sponsors of investment-based employee plans to strictly apply the fiduciary duties of prudence under the Employee Retirement Income Security Act (ERISA) when considering plan investments that promote nonfinancial objectives, such as reducing carbon emissions. A
separate Trump administration final rule would have barred retirement plan fiduciaries from casting corporate-shareholder proxy votes in favor of social or political positions that don’t advance the financial interests of retirement plan participants.

Duties of Prudence and Loyalty

Under the Biden administration, the DOL takes the position that ESG factors, and climate change issues in particular, pose financial risks that plan sponsors should consider as prudent fiduciaries.

According to a DOL fact sheet, the proposed rule “retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on material risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan,” a position similar to the prior guidance.

The proposed rule, however, also “addresses the [DOL’s] concern that the 2020 [Trump administration] rules have created uncertainty and are having the undesirable effect of discouraging ERISA fiduciaries’ consideration of climate change and other ESG factors in investment decisions, even in cases when it is in the financial interest of plans to take such considerations into account.”

Acting Assistant Secretary for the Employee Benefits Security Administration Ali Khawar said the new proposal “will bolster the resilience of workers’ retirement savings and pensions by removing the artificial impediments—and chilling effect on environmental, social and governance investments—caused by the prior administration’s rules.” 

He added, “A principal idea underlying the proposal is that climate change and other ESG factors can be financially material and when they are, considering them will inevitably lead to better long-term risk-adjusted returns, protecting the retirement savings of America’s workers.”

ESG Default Investments

The proposal also
reverses the prior rule’s prohibition on using ESG funds as qualified default investment alternatives (QDIAs), which are types of mutual funds that plan sponsors can select as the default option in automatic enrollment 401(k)-type defined contribution plans.

QDIAs can be target-date retirement funds, which automatically reset their asset mix to become less risky as the specified target retirement year nears. Mutual fund companies have begun marketing target date funds comprised of investments that meet their ESG criteria.

“This will be a huge win, if the final rule ends up looking like the proposal, for some asset managers who rolled out ESG target date funds over the past few years,” Jason Roberts, CEO of the Pension Resource Institute consultancy in San Diego, told RIABiz, an online publication for investment advisors.

Comments Sought

The comment period for the proposed rule will run through Dec. 13, 2021. Comments can be submitted at

Conflicting Views on ESG Funds

Wall Street Journal opposing opinion columns last month, two economics professors at Northwestern University’s Kellogg School of Management in Evanston, Ill., squared off over the appropriateness of ESG funds in retirement plans.

Aaron Yoon, an assistant professor of accounting and information management, wrote that “Offering employees the option of investing in [ESG] funds in their 401(k) retirement-savings plans is essential. If individuals are making clear that they want the option to invest this way, there is no good reason to deny them the opportunity to do so in their 401(k) accounts.”

He wrote that
research he conducted with colleagues showed companies with good ESG ratings relevant to the sector in which the company operates delivered superior stock returns.

In a counter-argument, Phillip Braun, a clinical professor of finance and associate chairman of the finance department at the Kellogg School of Management, wrote that ESG funds “tend to be more expensive than other funds”—and that according to
a Morningstar study, the asset-weighted average expense ratio of U.S. ESG funds was 0.61 percent in 2020, compared with 0.41 percent for all U.S. open-end mutual funds and 0.11 percent for traditional index funds. He noted that higher fund fees are correlated over time with lower returns on dollars invested, compared to similar funds with lower fees.

“Determining whether a stock or a fund is truly advancing ESG goals is difficult because the investment industry lacks a comprehensive ESG measurement framework,” Braun added. “Even those who are willing to pay extra to support sustainability and a ‘green’ agenda cannot be sure that ESG funds deliver on that either.”

Related SHRM Articles:

401(k) ‘Windows’ Reconsidered as Portals for ESG Investments,
SHRM Online, July 2021

DOL Won’t Enforce Rules Limiting 401(k) Plans’ Use of Nonfinancial Factors,
SHRM Online, March 2021

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