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Sustainable Investing

Sustainability Matters: Overwhelming Opposition to Proposed Regulation Limiting the Use of ESG in Retirement Plans

Investors take exception to Department of Labor proposal in public comments.

The U.S. Department of Labor has proposed a rule that would limit the use of investments that consider environmental, social, and corporate governance factors in worker retirement plans subject to ERISA, including 401(k) plans.

The proposed rule questions the financial materiality of ESG issues and assumes that ESG-focused investment strategies and funds are primarily focused on providing “nonpecuniary” benefits, often at the expense of “pecuniary” benefits, otherwise known as risk-adjusted returns. As a result, the proposal lays out burdensome new rules for the conditions under which plan fiduciaries can include ESG investments and out-and-out bans them from being designated as qualified default investment alternatives in 401(k) plans.

As you might guess, I am opposed to the rule and detailed my views on it in a recent column. My colleague John Rekenthaler also covered the topic. But, curious about what others thought about it, I gathered a group of interested colleagues to download and read the public comments submitted during the 30-day comment period that ended July 30, 2020. All 8,737 of them.

When a federal agency proposes a rule like this one, it must allow for public comment over a period that is typically 60 to 90 days. In this case, the DOL provided for only a 30-day comment period on a matter of significant and growing interest to investors and retirement-plan participants and beneficiaries. Despite this unusually short comment period, the Notice of Proposed Rulemaking drew 8,737 comments, including several petition letters signed by thousands of individuals.

While the DOL is required to read and consider the arguments made in the comments before making a final determination, I think the short comment period and the short time before the November election indicates an intention to rush through a final rule.

Before that happens, it may be of interest to know what the public and interested parties had to say about the proposal. Indeed, the DOL must carefully consider the comments and address major concerns raised by commenters prior to approving a final rule.

Our research team noted whether each comment expressed support for or opposition to the proposed rule and placed it into one of three overarching groups--individuals, investment-related firms and organizations, and non-investment-related firms and organizations.

Overwhelming Opposition What we found was that public comments were overwhelmingly opposed to the proposed rule. In fact, that might be an understatement, given that 95% of comments were opposed.

To be sure, most of the comments came from individuals, and one petition from Green America drew more than 7,000 signatures. And while that represents an impressive mobilization of grassroots opposition, we were equally interested in the firms and organizations that commented and what they had to say.

Somewhat surprising to me was that the level of opposition was equally as high among investment-related firms and organizations. Of 229 comments from investment professionals, 94% were opposed to the proposed rule, only 2% were in favor, and 4% were mixed or neutral. Not a single comment in support of the proposal was received from investor associations, pension plans, or asset owners.

Asset managers were nearly unanimous in their opposition, with only one out of 86 comments in favor. Opposing comments came not only from asset managers focused on ESG investing but also from many large conventional asset managers, including BlackRock, Fidelity, State Street Global Advisors, T. Rowe Price, and Vanguard. The single supportive comment came from a small exchange-traded fund firm called Vident Financial. Financial service providers, including Morningstar, opposed the rule 24 to 2, with one mixed/neutral comment.

Similarly, financial advisors voiced strong opposition, with 44 of 46 commenters opposing the rule. It is also likely that many more financial advisors were among the more than 8,000 individuals who registered their opposition.

Nearly all of the supportive comments on the rule came from outside the investment industry, focused among conservative trade associations and policy advocacy groups, including the American Conservative Union, American Legislative Exchange Council, National Association of Manufacturers, National Taxpayers Union, National Shooting Sports Foundation, and the Western Energy Alliance.

Even among trade and policy advocacy organizations generally, more comments opposed the proposed rule than supported it. Examples include the American Bankers Association, American Council on Renewable Energy, Center for American Progress, Citizens Climate Lobby, Public Citizen, and the Sierra Club.

Key Points Made in Opposing Comments We identified six key points commonly made by commenters opposing the proposed rule:

1) The proposal is not based on evidence that a problem actually exists. The proposed rule does not establish that retirement plan fiduciaries are misusing ESG or that they are selecting investments that give up financial returns in favor of nonfinancial benefits.

Putnam Investments noted in its comment that the rule treats "all ESG approaches as if they involve intentional sacrifice of returns," but that purported harm to returns is "based on limited evidence" and overstates the purported problem. T. Rowe Price noted that "the proposal is premised on an assumption--unsupported by any cited facts--that ERISA fiduciaries are currently misusing ESG." Impax Asset Management LLC included an extensive list of over 320 studies that establish positive links between various aspects of sustainability and financial performance of both firms and funds.

2) The proposed rule largely dismisses the financial materiality of ESG issues and ignores research regarding the materiality of ESG in financial decision-making. The proposal contains no references to the significant body of research, including peer-reviewed academic publications and other detailed studies, about the materiality and relevance of incorporating ESG factors into investment decisions nor to those that assess the performance of ESG funds relative to conventional funds.

The Defined Contribution Institutional Investment Association stated,"Members of the DCIIA community believe the Proposed Rule fails to acknowledge the many academic studies, research and industry reports that have found ESG risk factors are pecuniary, have shown improved investment performance when ESG risk factors are incorporated in the investment process, and have provided other financial-based benefits." Many comments referenced the work of the Sustainability Accounting Standards Board, whose extensive work on the materiality of ESG factors and maps of those factors to specific industries and sectors is increasingly accepted by asset owners and asset managers.

3) The proposed rule is based on a flawed and unsupported assumption that ESG funds give up financial returns in favor of "nonpecuniary" rewards. Many of those who oppose the rule argue that the assumption that ESG incorporation harms funds' financial returns is simply unwarranted.

BlackRock, for example, noted that "enhanced data and insights make it possible to create sustainable portfolios without compromising financial goals. Our research, which relies on back-tested data, shows how ESG-focused indexes have matched or exceeded returns of their standard counterparts, with comparable volatility. We find that ESG has much in common with existing quality metrics, such as strong balance sheets, suggesting that ESG-friendly portfolios could be more resilient in downturns."

4) Rather than being subjected to additions burdens and restrictions, incorporating ESG factors into investment decisions should be considered a part of fiduciary duty. Most of those who commented on the proposed rule not only took exception with the rule's presumption that ESG factors are "nonpecuniary" and harm returns but also argue that many ESG factors are material to financial performance and, as such, consideration of those factors should be included in the concept of fiduciary duty.

A sampling of the comments:

  • "It is our strong view that the EBSA should make ESG considerations a bedrock of fiduciary duty rather than discourage the practice."--Legal & General
  • "The Department needs to clarify that, when ESG issues present material risks or opportunities, ERISA's fiduciary duties would compel qualified investment professionals to consider them. U.S. investors are already considering ESG in engagement and investment decisions. The financial effects of ESG issues could manifest in the short, medium and long term. Because of the financial impacts and risks of ESG issues, and because ESG investments, on average, provide comparable or superior returns to non-ESG investments, it is a violation of fiduciary duty to not consider ESG in investment decisions"--ClearBridge

5. Excluding ESG investments from QDIAs in defined-contribution plans is inappropriate and could harm plan participants/beneficiaries. Noting widespread evidence on the materiality of ESG factors, commenters argued that exclusion of ESG funds from QDIAs is inappropriate and could hurt pension fund beneficiaries. Plan fiduciaries should be incorporating ESG, not be banned by regulators from considering it.

Putnam Investments, for example, noted that, “Indeed, the Department now permits the use of private equity components within plan investment options, including qualified default investment alternatives (QDIAs). This action, which we support, seems to reflect a fundamental belief in plan fiduciaries’ ability to assess and understand investments far more complex than ESG options. Based on the Proposal, an illiquid private equity investment strategy may form a component of a QDIA, yet a broad-based, liquid ESG-focused equity fund, competing against traditional investment benchmarks through investment in the stocks of large capitalization U.S. companies, cannot.”

State Street also echoed the sentiment, saying "Permitting the use of a prudently selected ESG fund as a QDIA is also consistent with the Department's QDIA regulation, which 'does not identify specific investment products--rather, it describes mechanisms for investing participant contributions.' Respectfully, we believe the same analysis should apply to ESG funds."

6) Singling out ESG for a heightened level of scrutiny and restriction is inappropriate and unwarranted. Several comment letters noted instances where "nonpecuniary" factors may be used in pension plans, but none except ESG considerations were singled out for exclusion or burdensome requirements.

In its comment, Fidelity noted, "Many plans offer company stock. Fidelity data shows that, as of 12/31/2020, 45% to 64% of corporate individual account plans with 5,000 or more participants offer company stock in their plan investment line-ups. Is a plan fiduciary required to justify the inclusion of company stock based solely on 'pecuniary' factors and, on a related note, what comparable 'available alternative investments or investment courses of action' would a typical fiduciary be required to consider?"

Before it imposes unnecessary regulation, let’s hope the DOL will respond to these points by carefully considering the research and listening to investment experts rather than to a few trade associations and policy advocacy groups that have little investment expertise.

Jon Hale ( has been researching the fund industry since 1995. He is Morningstar’s director of ESG research for the Americas and a member of Morningstar's investment research department. While Morningstar typically agrees with the views Jon expresses on ESG matters, they represent his own views.

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