US proposes reversing Trump-era rules on ESG investing

The new regulations would make it possible for funds with environmental and other focuses to become the default investment option in retirement plans.
The new regulations would make it possible for funds with environmental and other focuses to become the default investment option in retirement plans.PHOTO: REUTERS

NEW YORK (NYTIMES) - The US Labor Department proposed rule changes on Wednesday (Oct 13) that would make it easier for retirement plans to add investment options based on environmental and social considerations - and make it possible for such options to be the default setting upon enrollment.

In a reversal of a Trump-era policy, the Biden administration's proposal makes clear that not only are retirement plan administrators permitted to consider environmental and social factors, it may be their duty to do so - particularly as the economic consequences of climate change continue to emerge.

Labor Secretary Marty Walsh said the department consulted consumer groups, asset managers and others before writing the proposed rule and that the change was considered necessary because the old one appeared to have a "chilling effect" on using environmental, social and governance factors, better known as ESG, when evaluating investments.

"If these legal concerns were keeping fiduciaries on the sidelines, it could mean worse outcomes for workers and retirees," Walsh said.

The new regulations would also make it possible for funds with environmental and other focuses to become the default investment option in retirement plans such as 401(k)s, which the previous administration's rules had prohibited. But the rule would not permit plan overseers to sacrifice returns or take on greater risks when analyzing potential investments with a focus on ESG, Labor Department officials said.

Aron Szapiro, head of retirement studies and public policy at Morningstar, said the proposed rule change would help bring retirement plans more in step with how the broader investment industry considered ESG factors.

"The Trump regulation was poorly constructed, the economic analysis was deeply flawed and I think it was really out of step with what are increasingly common practices that are designed to incorporate ESG as financially material pieces of information," he said.

The proposed change indicates plan managers are allowed to consider ESG factors in their initial analysis of investments instead of only at the very end - a change that Labor Department officials argued still maintains that principle, because managers still are not permitted to sacrifice returns for those kinds of ancillary benefits.

For example, the proposed rule said that accounting for climate change, "such as by assessing the financial risks of investments for which government climate policies will affect performance" can benefit retirement portfolios by mitigating longer-term risks.

"If an ESG factor is material to the risk-return analysis, that is something we think fiduciaries should be taking into account," Ali Khawar, an acting assistant secretary in the department, said in an interview. "That carries different weight than five or 10 or 15 years ago," he said, given the increase in data quantifying the risks of ignoring ESG and the benefits of taking them into account.

The investment category has grown significantly in recent years. Total assets in ESG funds rose to US$17.1 trillion (S$23.1 trillion) at the start of 2020, up 42 per cent from the start of 2018, according to the US SIF, a nonprofit focused on sustainable investing. That investment total represents one in every three dollars under professional management.

Just a small fraction of those investments are held by retirement plan investors, a US SIF report said, even as interest is rising, particularly among younger investors.

The growing interest has prompted the Securities and Exchange Commission to seek public comment on requiring companies to disclose climate risks.