The Department to Labor (DOL) made a last-minute pivot in rolling out its latest investment-selection rule, removing a wrinkle that could have given some defined contribution (DC) plan sponsors pause in considering purpose-driven investments. In doing so, lawmakers seemed to acknowledge our view that ESG factors are financial, too.
When the DOL recently issued its final rule, called Financial Factors in Selecting Plan Investments, something was missing: any reference to strategies with an environmental, social and governance (ESG) theme in ERISA plans. It was a notable change to language in the proposed rule that had elicited a strong negative response from the investment community.
Potential Selection and Monitoring Burden Removed
The DOL received over 8,000 comment letters on the rule, including ours. The feedback generally argued that ESG factors are indeed financial factors (or “pecuniary” factors, in the DOL’s lexicon) when deciding the appropriateness of an investment for a DC plan. In striking the ESG references, the DOL seemed to acknowledge both the comments and that ESG isn’t consistently defined and should be omitted.
No longer specific to ESG, the new rule essentially codifies the fact that fiduciaries must select investments based only on financial factors. That’s good news for ESG investing: while we didn’t believe that the proposed rule was a big change from the existing rules, it might have encumbered the selection and monitoring process for purpose-driven portfolios in DC plans.
ESG Considerations Are Financial Considerations
With the ESG language absent from the final DOL rule, the focus when selecting DC plan investments is squarely on financial considerations. That’s good, because as we see it, ESG considerations must be a critical component of in-depth fundamental research in any investment solution—whether that solution has an explicit ESG label or not.
For example, a company that emits a lot of carbon is exposed to carbon taxes—and those taxes are likely to grow over time. The firm might also face higher operating costs from legally mandated equipment upgrades. Longer term, the business risks losing market share to competitors who develop low-carbon alternatives—a changing of the guard that also highlights the potential positive financial impacts from ESG.
In short, ESG considerations are financial considerations, and for investors and plan sponsors looking for ways to invest responsibly, the DOL’s course change on ESG-themed investments in its latest rule is a welcome development.
When the bottom line is achieving better financial outcomes, plans can and should take an ESG integration lens across the investment lineup. For DC plan sponsors, we think ESG considerations should be front and center in seeking to promote better financial outcomes for participants—and invest for purpose in the process.