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

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 LoyaltyUnder 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 InvestmentsThe 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 …