ESG Investments in Retirement Plans: Considerations for Plan Sponsors

As part of the Biden Administration’s whole government approach to addressing climate change, the Department of Labor (DOL) published proposed rules on selecting plan investments that are far more favorable to environmental, social, and governance (ESG) focused investments than final rules adopted by the Trump Administration’s DOL. These proposed rules are a significant departure from past rules and may warrant an adjustment in approach on this topic.

What Should Retirement Plans Do About ESG Investing?

The Employee Retirement Income Security Act (ERISA), which governs most retirement plan investment decisions, requires that plans make investment decisions solely in the financial interests of plan participants, and with sufficient care, skill, and prudence. While the current DOL appears to believe ESG-focused investing in retirement plans can be prudent, it is important to remember that the DOL’s latest guidance does not change the fundamental duty to prioritize participants’ investment returns.

ESG-Focused Investment

Plans investment fiduciaries should consider carefully whether and how to implement any ESG-focused investment strategies. Below are a few questions plans might ask when considering an ESG-focused investment:

• Is the investment expected to outperform other available investments? Each plan investment must be prudent. Plans should consider whether a potential investment is likely to be more financially beneficial for plan participants than other available investments (regardless of ESG-status), and should be able to explain the reasons for its conclusion. The current DOL administration appears to believe that ESG factors can contribute to performance, but that does not alleviate the fiduciary from engaging in a robust analysis comparing the investment to other non-ESG alternatives.
• What makes the investment “ESG”? If the fiduciary believes ESG factors contribute to performance, the fiduciary should evaluate whether the investment under consideration focuses on environmental factors. Social issues? Corporate governance policies?  Plans should understand an investment’s focus so that it can evaluate the investment in the selection process.
• Is the investment’s ESG focus genuine? Commentators and regulators have raised concerns about “greenwashing” by some ESG-labeled investments (i.e., funds claiming to be more environmentally focused than they are). To the extent the plan fiduciaries place value on ESG factors, they should take steps to ensure an investment will deliver the ESG benefits it advertises.
• How would the investment fit within the plan’s overall investment lineup? Individual plan investments typically are intended to serve a specific role as part of an overall investment lineup (e.g., providing participants exposure to U.S. large-cap growth equity). Plans should consider how any new investment would fit into the overall lineup.

While the DOL’s guidance on ESG investing has shifted several times in recent years (and might shift again in the future), ERISA’s basic requirement that plan investment decisions be made prudently and solely in the financial interests of participants has not changed. Plan administrators should ensure that their plan fiduciaries are continuing to follow a prudent process to ensure that any plan investment (ESG or otherwise) serves that goal.

 

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