How ESG Factors Should Affect Pension Investments

Pension plan sponsors could be forgiven for having whiplash when it comes to the Department of Labor’s tone on environmental, social, and governance (ESG) matters.

Over the years, the DOL’s publications on incorporating ESG funds into plans subject to the Employee Retirement Income Security Act (ERISA) have flipped from positive to negative, and back again. The most recent guidance seems to skew toward the negative.

In a Field Assistance Bulletin published April 23, John Canary, director of regulations and interpretations, tells ERISA enforcement field officers that “fiduciaries must not too readily treat ESG factors as economically relevant” when choosing investment products for plan participants. He continues: “It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors. Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits.”

While the bulletin does not overtly reverse previous statements from the DOL, and in essence restates an abiding emphasis on investment performance and costs as paramount considerations for fiduciaries, the phrase “must not too readily” will likely give plan sponsors pause, says Kenneth Raskin, chairman of the Plan Sponsor Council of America (PSCA) and a partner at law firm King & Spalding. With this most recent guidance, Raskin says, “it’s just a little more difficult for a fiduciary to go down that road. It doesn’t help fiduciaries invest in ESGs.”

The data show that sponsors already are leery. In 2016, ESG funds were an option in just 2.4 percent of retirement benefit plans, according to a PSCA survey of 590 plan sponsors published earlier this year.

“There’s already not a lot of interest in this” on the part of plan sponsors, Raskin notes.

The April 23 guidance is especially firm when it comes to the question of ESG-themed investments as qualified default investment alternatives (QDIAs). “Nothing in the QDIA regulation suggests that fiduciaries should choose QDIAs based on collateral public policy goals,” the guidance warns.

Alex Bernhardt, head of responsible investment U.S. at Mercer, agrees that the ERISA guidance is likely to have a chilling effect on plan sponsors. But, he adds, it was already clear from existing employment law and regulation that due diligence is paramount for fiduciaries, no matter what style of investments they are considering for participants. “The process is the same and similarly robust,” Bernhardt says.

The recent guidance serves as a reminder of that process, no matter the type of investment product. “The emphasis on due diligence has been heightened,” Bernhardt says. At the same time, “responsible investing isn’t going away.” The United Nations’ Principles for Responsible Investment has more than 1,000 signatories, accounting for over $70 trillion in assets. Investment managers worldwide are interested in ESG factors. So are ratings agencies.

Some see a different overarching message in the April DOL guidance: ESG factors are, in fact, economic measures worthy of careful consideration, which should absolutely be taken into account when performing due diligence as a fiduciary. Susan Gary, a professor at the University of Oregon School of Law and author of a recent paper, “Best Interests in the Long Term: Fiduciary Duties and ESG Investing,” published in the University of Colorado Law Review, views the DOL’s guidance as “confirmation of the potential importance of ESG factors” and says that she found the missive “interesting and helpful.”

Gary points to a key passage in the guidance where, in her view, the DOL reiterates its previous view that there “could be instances when otherwise collateral ESG issues present material business risk or opportunities to companies that company officers and directors need to manage as part of the company’s business plan and that qualified investment professionals would treat as economic considerations under generally accepted investment theories.

“In such situations,” the DOL guidance continues, “these ordinarily collateral issues are themselves appropriate economic considerations, and thus should be considered by a prudent fiduciary along with other relevant economic factors to evaluate the risk and return profiles of alternative investments.”

Gary views this statement as a sign the DOL recognizes that ESG factors are indeed potentially material to investment performance. “When material ESG factors do have financial impact, they should be considered by a prudent fiduciary, and the guidance confirms this understanding of the prudent investor standard,” Gary writes.

Plan sponsors may not share her perspective, but by issuing additional guidance that does not negate prior doctrine, the DOL has succeeded in keeping ESG factors top-of-mind for a variety of stakeholders.