Considerations for ESG Investing in Retirement Plans

“I’ve been hearing a lot lately about ESG investing. What is it, and are there things we should consider before adding it to our plan?”

Charles Filips, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

Environmental, social and governance (ESG) factors have attracted significant attention lately. Though definitions vary, examples of each category include investing with an eye towards addressing global warming, reducing pollution (E), enhancing diversity, human rights, and consumer protection (S), or investing in companies with transparent accounting, strong risk and crisis management, and strong supply chain management (G).

The arguments supporting consideration of ESG factors vary. Some have articulated ESG investing is a way to try to do good while also getting an investment return. Others have articulated it as a way to encourage greater investing by allowing individuals to invest in things that align with their moral values. Still others have argued for the consideration of ESG factors by saying that the use of ESG factors can be an economic consideration where less ESG compliant companies could face future liability or regulatory disadvantages if they are perceived as causing societal harm.

In the retirement space, the primary argument against consideration of ESG factors is that retirement plans are designed to further a specific social good, which is to reduce the risk that retirees will have insufficient money to live in dignity, and that consideration of other goals could reduce the total amount of assets available to ensure that that goal is met.

Recently, the Department of Labor (DOL) issued a proposed rule, “Financial Factors in Plan Investments.” The proposed rule follows prior guidance, primarily in Field Assistance Bulletins, where the department had articulated that a plan fiduciary may consider ESG factors if they truly are economic (“pecuniary”) factors, and where “all things are equal,” may be a “tie-breaker”—but a fiduciary is still statutorily-bound to manage investments with an ‘‘eye single’’ to maximizing the funds available to pay retirement benefits.

The proposed rule affirms the department’s view that ESG factors can be used as a tiebreaker when everything else is equal, but the department cautions that rarely, if ever, will all things be equal. In addition to this cautioning, the department adds recordkeeping requirements when plan fiduciaries consider “non-pecuniary” factors and suggests that plan fiduciaries should not include investments that consider ESG factors as part of a default investment option or qualified default investment alternative (QDIA). While the proposed rule is not a final rule, and while many commenters suggested that the department go back to the drawing board, plan fiduciaries may want to consider this new guidance when evaluating the continued use of ESG factors or the adoption of new ESG factors.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.