US Department of Labor removes ESG investment barrier with final rule

Regulator reverses Trump-era rules that limit how workplace pensions can address ESG issues.

The US Department of Labor has announced a final rule allowing US workplace pension schemes to consider ESG factors when selecting investments, including for default funds, and exercising their shareholder rights around proxy voting.

A review of the rule, titled “Prudence and loyalty in selecting plan investments and exercising shareholder rights”, was called for by President Biden as part of his executive order on climate-related financial risks, published in May 2021. 

Following consultation on a draft rule put out by the DoL in October 2021, the regulator concluded that two rules issued in 2020 under the Trump presidency “unnecessarily restrained plan fiduciaries’ ability to weigh environmental, social and governance factors when choosing investments, even when those factors would benefit plan participants financially”. 

Lisa Gomez, assistant secretary for employee benefits security at the DoL, said the rule announced on Tuesday “will make workers’ retirement savings and pensions more resilient by removing needless barriers, and ending the chilling effect created by the prior administration on considering environmental, social and governance factors in investments”.

The Trump-era rules, which only came into effect in January 2021, required workplace pension schemes to solely consider financial factors when selecting investment funds or voting proxies.  

Many in the sustainable investment industry saw those changes to Employee Retirement Income Security Act (ERISA) – the rules that govern workplace pension funds, such as 401k plans, and which are enforced by the DoL – as an attempt to make it harder for scheme fiduciaries to consider ESG factors. 

Legal & General Investment Management America’s head of US stewardship and sustainable investments, John Hoeppner, told affiliate title Responsible Investor last year that “market sensitivity” to the DoL’s rules was a major obstacle to ESG uptake in the US. 

“When you take a huge step back and consider what is really holding the US market back, it is still just one singular thing: market sensitivity to the DoL – their interpretations, rulings on ESG integration and the ripple effect of litigation fear that causes investment committee inertia,” he added. 

The DoL also cited concerns from stakeholders that the 2020 rules created confusion and were having “a chilling effect on appropriate integration of ESG factors in investment decisions”.

Other concerns related to a special provision in the 2020 rules, under which “funds would not be treated as qualified default investment alternatives (QDIAs) solely because they expressly considered climate change or other ESG factors, even if the funds were prudent based on consideration of their financial attributes alone”. 

The final new rule removes those special provisions and applies the same standards to QDIAs as it does to other investments.  

The Principles for Responsible Investment’s (PRI) head of US policy, Greg Hershman, welcomed the final rule making, which “removes barriers that hindered managers’ consideration of climate risk and other ESG factors when making investment decisions and exercising shareholder rights”. 

He added that the DoL “must continue to look for ways to provide clarification to market participants on the growing use cases of ESG factors, including in understanding investment implications for real-world outcomes”. 

The final rule will be effective 60 days after its publication in the Federal Register, except for a delayed applicability until one year after publication for certain proxy voting provisions to allow fiduciaries and investment managers additional time to prepare.