The Biden administration is giving an assist to self-directed retirement plans struggling to keep up with an investment landscape that’s rapidly turning a more vibrant shade of green, easing Trump-era restrictions and hinting at broader guidance that could make investing to protect the environment a default choice.
The administration wants to make good on an ambitious climate change agenda that’s been otherwise mired by congressional infighting on Capitol Hill. To do that, President
It’s a precarious balancing act that pits individual investment control and a free-market economy against a common interest in resilient retirement income that protects already-strained social safety net programs.
1. How does climate change affect retirement plans?
Extreme heat waves, year-round fire seasons, and unprecedented coastal flooding prove that climate change is happening. Companies combating that trend by supporting alternative energy or reducing emissions stand to reap huge financial rewards, while coal, oil, and gas companies face increasing pressure from investors and an uncertain future.
Those financial risks and rewards trickle down to investors in the form of favorable stock performance and dividends. Most 401(k) participants access the market through a set of funds they choose, each of which stack their portfolios to eliminate risks and maximize the return on investment.
But retirement plans themselves also have a lot of weight to throw around in the market. Of the $22.8 trillion in outstanding domestic stock, retirement accounts hold roughly 37%, according to the Tax Policy Center. That’s the largest total share of investments of any other asset class by far, outstripping taxable brokerage accounts, insurance, and nonprofit investments combined.
It stands to reason that, however most U.S. retirement plans are choosing to invest, the companies on the receiving end of those investments stand to gain, and most of the rest of the stock market is likely to follow.
2. Why is the government involved?
Retirement accounts are a reflection of the broader investment market, but government protections designed to secure workplace savings from abuse can also make plans less responsive to sudden change.
The Labor Department applies a strict fiduciary standard of care that retirement plan officials must use when they make investment decisions such as which funds to offer in a 401(k) or which stocks to invest in a traditional pension plan. An employer that fails to apply the fiduciary standard can be held responsible for bad investments, costing millions in court fees or settlements.
That leaves retirement plans wary of contemporary investment strategies, especially if they lack the resources to mount a challenge.
Institutional investors have more than doubled total assets invested in green energy since 2014—a trend that’s already engrossed many of the nation’s largest public pension plans. Just this week, the $280 billion plan covering New York state workers announced that it would divest in shale oil and gas production. Meanwhile, less than 3% of 401(k) or 403(b) plans offer green investment options, according to the Plan Sponsor Council of America.
3. What is the Labor Department doing?
Biden’s first move to address the climate-retirement asset gap is an effort to undo a regulation former President
Climate-friendly investments have proven financially sound in the wake of recent extreme weather events, but Biden’s Labor Department said the Trump rule would have a “chilling effect” on environmental, social, and corporate governance, a mainstream investment strategy dubbed “ESG.” The president froze that rule and proposed a new one in October that expressly permits financially material green investing.
The proposed ESG rule breaks new ground by suggesting—for the first time—that fiduciaries’ duty of prudence “may often require” them to consider the economic effects of climate change or the way the federal government seeks to address it, directly tying financial materiality to government action and Biden’s regulatory agenda on climate.
The rule amassed thousands of public comments, many of which accused Biden of choosing winners and losers in the market. Major investment firms such as The Vanguard Group Inc.,
4. What are the next steps?
The DOL recently published a request for information from relevant investment industry stakeholders about what else it can do to mitigate the risk climate change poses to private-sector workplace retirement accounts.
Industry watchers and retirement plan practitioners say they think the results of that input could be subregulatory guidance that pushes an environmentally friendly retirement investing agenda even further. The department regularly relies on advisory opinions and frequently asked questions to clarify its stance on important fiduciary controls.
One area of particular focus is default investments, where workers’ money is automatically invested if they don’t manually choose a fund. ESG proponents want the Labor Department to explicitly say that 401(k) plans can choose to safeguard that money in environmentally friendly funds.
The president’s proposed ESG rule could jump-start a whole new category of green investment products tailored to retirement investors.