An under-the-radar regulatory effort could encourage investors to alter how they weigh the risk of investments by private-sector employee benefits plans governed under the Employee Retirement Income Security Act of 1974.
In January, President Joe Biden issued an executive order directing executive departments and agencies to review federal regulations that conflicted with the federal government's mission to "advance environmental justice," with a particular emphasis on climate change.
One such agency, the U.S. Department of Labor's Employee Benefits Security Administration, took action under Biden's order in deciding not to enforce a Trump administration rule that would have required employee benefit plan fiduciaries to "select investments and investment courses of action based solely on financial considerations relevant to the risk-adjustment economic value of a particular investment or investment course of action."
The Trump-era rule, adopted by EBSA in November 2020, particularly sought to address the rising trend of investment decisions that took into account so-called "ESG factors," or environmental, social and governance factors. Specifically, the Trump administration spelled out that "plan assets may never be enlisted in pursuit of other social or environmental objectives at the expense of ERISA's fundamental purpose of providing secure and valuable benefits."
The 2020 rule did recognize instances in which ESG factors could present an economic business risk or opportunity that fiduciaries could appropriately treat as material economic considerations. But a variety of stakeholders in the employee benefits community had a negative response to the rule's treatment of these factors, according to Ali Khawar, acting assistant secretary for EBSA.
In a Nov. 17 webinar presented by sustainability advocacy organization Ceres, Khawar discussed the Biden administration's rationale and process for revoking the 2020 rule as well as issuing its Oct. 14 proposed rule that would amend EBSA's regulations to clarify, among other points, that plan fiduciaries may need to evaluate the economic effects of climate change and other ESG factors in determining the projected return of a portfolio relative to the funding objectives of the plan.
Khawar said regulators sought to engage a wide range of stakeholders in developing the new regs, including investor advocates, issue advocates, labor unions, plan sponsors, corporations, trust companies and plan advisors, among others. "A big part of our approach to this issue has been to talk to the people that are on the front lines and to do a lot of listening," he added. "It was remarkable how much of what we heard from stakeholders was consistent."
Specifically, Khawar said that although some stakeholders believed the Trump administration rules on ESG factors took a middle-of-the-road approach to the issue, "it continued to have a chilling effect on investor behavior." In other words, stakeholders were considering plans to take climate change and other ESG factors into account during their decision-making processes, but the 2020 rule either put those efforts to a halt or reversed them, Khawar said.
Khawar said the new rule seeks to make clear that ESG factors are no different from other considerations investors may have; "When it comes to ESG factors, there's really nothing different about them from anything else that's material. There are times when you take them into account and times when you shouldn't."
"That's a very context-specific analysis, but we really don't think we should be putting our finger on the scale to say ‘you really shouldn't be doing this,'" he continued.
Public comments on the proposed rule are due Dec. 13, and Khawar said EBSA welcomes constructive input, particularly with respect to evidence of the materiality of ESG factors and relevant research to which stakeholders believe the agency should be paying attention.
EBSA also is looking to receive comments about the hesitancy of plan sponsors to adopt ESG factors, Khawar noted, and how stakeholders handle a "tiebreaker." That term refers to a situation in which investors must choose between multiple options that have an equivalent impact on a portfolio's needs.
"What we said in our NPRM is that once you're at that point and you're choosing between equivalent options, we haven't really put a lot of restrictions on how you choose at that point," Khawar said. "It could be anything. It could be ESG factors, it could be something that's not an ESG factor." The agency is also asking stakeholders whether there are certain parameters it should consider putting into place around tiebreaker decisions.
But with respect to ESG factors specifically, Khawar said EBSA is not taking what he described as a "more aggressive approach" in telling investors what factors they must consider in investment decisions.
"No matter what your perspective is on ESG issues, to the extent that something is financially material, everybody should agree that getting better returns for retirement savers — that's a good thing," he continued. "And that's what I think the rule attempts to focus the conversation on."