The US Department of Labor (DoL)’s newly-proposed ESG rules would dissuade fiduciaries from assessing financially material ESG risks and opportunities, US sustainable finance organisation Ceres has told the government division in a letter.
Last month, the DoL’s Employee Benefits Security Administration proposed a new rule regarding ESG considerations when selecting plan investments.
The rule – known as Financial Factors in Selecting Plan Investments (1210-AB95) – hinged on the idea that ESG investing meant sacrificing returns, and put forward new standards for fiduciaries to be able to choose an ESG option over a non-ESG one.
As the department oversees private-sector retirement schemes – around $9trn in assets, or about 30% of the value of the US stock market – the proposed rules would apply to corporate pensions and 401(k) plans, but not to retail investment accounts or non-corporate institutional portfolios like endowment funds.
Now, Ceres is warning that the proposal would “make it much harder for many pension plans and other fiduciaries to consider ESG risks in their investment decision-making”.
One of the reasons for this, Ceres says, is because the proposed rule “in effect redefines the ‘tie-breaker’ test” that a fiduciary has to meet when investing with “non-pecuniary” (non-financial) objectives.
Under the traditional tie-breaker test, “fiduciaries may not accept lower expected returns or take on greater risks in order to secure collateral benefits” – collateral benefits again meaning non-financial or ESG objectives.
According to Ceres: “The proposed rule appears to prohibit a fiduciary from moving forward with a non-pecuniary ESG investment unless such investment is identical in all respects, including, choice of benchmark, fee structure, performance history, investment strategy and underlying asset composition, with an alternative investment.”
The Department itself says in the proposed rules that it “expects that true ties rarely, if ever, occur”.
Ceres said the department’s own comments show the new test is “so onerous that…it is a standard in name-only”.
“In our view, the proposed rule’s reinterpretation of the tie-breaker test is in error and flies in the face of longstanding Department guidance and court precedent,” it said.
The letter, addressed to Jeanne Klinefelter Wilson, Acting Assistant Secretary at the department’s Employee Benefits Security Administration and signed by Ceres CEO and President Mindy Lubber, also denounces the DOL’s proposed rule regarding whether an ESG fund can be a qualified default investment alternative (QDIA) – a default option for pension savers.
According to the new rule, ESG or “similarly oriented” options cannot form part of QDIAs.
But Ceres says there is “already a well-understood protective framework in place with respect to the selection and monitoring of QDIAs” under ERISA fiduciary duties, which “obligates fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries”.
It explains that, even if an ESG-related QDIA had been chosen for non-financial reasons, the fiduciary would be bound by QDIA regulation, ERISA’s fiduciary duties and the traditional tie-breaker test.
The letter says: “The traditional tie-breaker test is an extra shield used to allow some breathing room for fiduciaries while protecting the interests of participants’ and beneficiaries’ in their retirement income, as required under ERISA. The Department should resist the temptation to reinvent the wheel by discarding this long-standing practice.”
The letter also asks the administration to acknowledge that ESG issues can pose material risks to investments.
“The proposed rule reflects an outdated view that ESG factors are non-financial and considering them can lower returns. The opposite is true. The evidence is clear that ESG issues pose short-, medium- and long term- financial impacts and risks that place them squarely within the category of any material, financial risks that are factored into investment decisions.”
The letter breaks down climate and ESG risks, and outlines the work of asset managers and data providers on the materiality of ESG risks to different industries and on climate as a systemic risk.
It asks the department to clarify that, when ESG risks are material, ERISA would compel qualified investment professionals to treat such ESG issues as economic considerations.
It finally asks the department to extend the consultation period on the proposed rules from 30 to 120 days. “Extending the comment period will provide investors and other stakeholders enough time to provide substantive feedback on the proposal,” it said.
The news came just one day after a similar challenge from the American Council on Renewable Energy, which also asked the DOL for a longer comment period and held that the proposed rule was “redundant to the requirements of existing law and therefore unnecessary to protect the interests of investors”.