Icy reception for DoL’s ESG proposal

The Department of Labor wants to adjust the rules regarding ESG in retirement plans. Financial advisors want none of it.

Of 46 advisors who gave feedback to the department during its comment period ending July 30, all but two expressed opposition to the proposal. That mirrors widespread criticism leveled against the Labor Department among the public feedback the agency received, according to a new analysis of the roughly 8,700 comments sent to the agency.

More than 95% of the comments opposed the Labor Department’s proposal, according to the analysis, which was conducted by six investor organizations and industry firms, including Morningstar and Impax Asset Management.

The Labor Department says its proposed rule would clarify the pre-existing mandate that fiduciaries may only consider pecuniary indicators when selecting funds for retirement plans. The proposal requires that fiduciaries be able to prove ESG funds they selected were economically superior to alternatives in their risk and return.

While fiduciaries can use ESG factors, “it is unlawful for a fiduciary to sacrifice return or accept additional risk to promote a public policy, political, or any other non-pecuniary goal,” the proposal says.

Many of the comment letters took this as an affront to sustainable investing.

“This innocuous sounding description conceals the real purpose of the [proposal], which is to limit the use of investments that consider [ESG] issues in worker retirement plans subject to ERISA,” according to the report.

ESG has become increasingly popular among asset managers and clients. Approximately 80% of investment professionals consider ESG criteria when making investment decisions, according to a 2017 research paper by Amir Amel-Zadeh, a professor at Said Business School at the University of Oxford, and George Serafeim, a professor at Harvard Business School.

“Fiduciaries are actually breaching their duty by not taking [ESG factors] into account,” says Fran Seegull, director of the U.S. Impact Investing Alliance, an organization raising awareness for impact investing. Climate change, the coronavirus pandemic, income inequality and systemic racism have financial implications for portfolios, she says.

Seegull anticipates the department’s proposal will put plan fiduciaries in a “tough position.”

In order for a plan fiduciary to incorporate ESG investments into their plans, they’d have to provide a paper trail proving that those investments were “economically indistinguishable” from non-ESG alternatives — a bar she claims the department has made “unreachable.”

Should a fiduciary make the comparison, “it creates compliance burdens and expenses on the plan sponsors and fiduciary, and ultimately the beneficiary,” she says.

Not all advisors are concerned, however. For Loreen Gilbert, who is affiliated with LPL Financial, the department wasn’t discouraging the use of ESG. Instead, it was necessitating financial advisors to perform adequate due diligence.

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Gilbert, who began adding ESG funds into client portfolios and retirement plans in the last year, says there is no streamlined definition for the term. Incorporating these funds into portfolios already mandates additional effort.

“There's not a real good way to just screen [them] out and say which funds are ESG,” Gilbert says. Environment, social and governance criteria can include racial diversity, gun control and climate change.

The analysis of the comment letters says the proposal is based on a “flawed and unsupported assumption” that ESG funds give up financial returns.

“Many ESG factors are material to financial performance and, as such, consideration of those factors should, in fact, be included in the concept of fiduciary duty,” the report says.