In June, the Department of Labor issued a proposed regulation, that if finalized, would be their strongest stance against investing assets of plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) in investments that incorporate non-pecuniary factors such as environment, social or corporate governance (ESG) considerations.
Instead, the proposal confirmed that ERISA requires plan fiduciaries to select investments or investment strategies based solely on pecuniary considerations. The DOL’s guidance appears to assume that achieving financial gains or maximizing profits are mutually exclusive from ESG collateral considerations.
To satisfy the requirement ERISA fiduciaries act solely and exclusively for the purpose of providing benefits to plan participants and beneficiaries, the guidance provides that fiduciaries are not permitted to subordinate economic interests—e.g., expected returns and expected risks—to policy goals such as social, environmental, or corporate governance goals.
The proposal is notable because it follows the administration’s April 2019 order, Promoting Energy Infrastructure and Economic Growth. In that order, which focused on financing energy infrastructure projects through capital markets, the DOL was directed to review data on ERISA retirement plan investments and discern any trends in those investments in the energy sector, such as a greater focus on renewable energy and a move away from fossil fuels. As such, this order sought to remove ESG considerations that may lead fiduciaries to invest in renewable energy investments instead of in energy infrastructure for coal, oil and natural gas.
However, because of state mandates to cut carbon emissions, environmental opposition and customer concerns for climate change, some energy companies are already abandoning pipelines for fossil fuels. The Keystone XL pipeline expansion which sought to transport oil from Canada to the U.S. Gulf Coast remains unbuilt. Some energy companies are looking to achieve reduced carbon emissions, developing wind and solar power and investing in clean technologies.
Against the Trend
The DOL’s proposal is also notable because appears to be contrary to the trend of sustainable investing and performance of sustainable investment. BlackRock found that more than three-quarters of sustainable indexes did better than traditional indexes in market downturns from 2015-2018. In addition, several leading investment management companies have found ESG investments outperformed traditional investments in 2020.
Nonetheless, similar to the DOL’s field assistance bulletin 2018-01 (FAB 2018-01), the proposal cautions fiduciaries against too readily treating ESG factors as economically relevant when making an investment decision. Under this prior guidance, ESG factors are only to be considered if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under accepted investment principles.
The current administration’s guidance is a departure from the guidance in the DOL’s interpretive bulletin 2015-01, which was issued by a prior administration. In that guidance, the DOL recognized that ESG may have a direct relationship to the economic and financial value of a plan’s investment. If a fiduciary prudently concludes that an investment is justified based solely on the economic merits of the investment, there is no need to evaluate collateral goals or “tie breakers.”
With the election just four months away and a possible change in the administration, the DOL will be incentivized to finalize the proposed regulation. If finalized, changing it would be more challenging. However, if there is a new administration and a potential change in the control of Congress, the regulation—if finalized—could be revised or overturned under the Congressional Review Act.
ESG, Financial Performance and Energy Investment
Investment firms increasingly consider ESG or sustainability factors as a risk management strategy to evaluate the potential long-term financial performance of an investment and not just traditional investment factors. With ESG ratings and rankings increasing, ESG is becoming a relevant factor for investment evaluation by investors. There is a growing interest in investments that deliver strong risk-adjusted returns while also providing a positive environmental impact. Investors cover a broad spectrum and include plans (such as government and church plans) that are not covered by ERISA or the DOL’s proposed regulation.
BlackRock announced a new standard for investment that incorporates sustainability and ESG factors. In the first quarter of 2020, BlackRock observed 94% of globally represented selection of widely analyzed sustainable indices outperformed their parent benchmark.
In April 2020, BlackRock closed its third and largest alternative investment fundraise of $5.1 billion for Global Energy & Power Infrastructure. Investors in that fund include public and private pension funds, sovereign wealth funds, foundations, insurance companies and non-profit organizations across the U.S., Europe, Asia, and the Middle East. The investments will consist of: the power sector, including electric power generated from renewable sources (solar, wind, hydro and waste-to-energy) and from natural gas, while excluding coal-generated power; the midstream sector, including energy transportation and storage; and the utility sector.
ESG and ERISA Plan Investments
In contrast, a 2018 Government Accountability Office study estimated that less than one in ten participant-directed retirement plans offer ESG investments and only three percent selected that option. Yet, according to Morningstar, the amount of assets invested in sustainable funds in 2019 was nearly four times larger than in 2018.
The preamble to the proposed regulation provides that about 0.1 percent of total ERISA defined contribution plan assets are invested in ESG funds. It is reported that at the end of the first quarter of 2020, total U.S. retirement plan assets stood at $28 trillion of which $7.7 trillion is held in defined contribution plans and $11 trillion is held in pension plans. No information was provided on any trend of investing ERISA retirement plan assets in renewable energy investments.
If the proposed regulations are finalized, it could be difficult for an ERISA fiduciary to justify an investment decision primarily based on ESG factors.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Candace L. Quinn is senior counsel in the Employee Benefits department in the New York office of Seyfarth Shaw LLP. She is an executive compensation and employee benefits attorney with significant international and domestic experience.
Linda J. Haynes is a partner in the Employee Benefits department in the Chicago office of Seyfarth Shaw LLP. She advises clients on the complex and ever-evolving ERISA fiduciary matters that affect plan fiduciaries today.
Ameena Y. Majid is a partner in the Employee Benefits department in the Chicago office of Seyfarth Shaw LLP. She helps her clients maintain their culture and retain employees through compensation and benefits incentives, and through policies that address human rights pursuant to international principles and emerging modern slavery disclosure laws.