From collateral to integral

At the core of the DOL pension policy is that “ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits.”

Arguments used against incorporating ESG factors into ERISA plans include the belief that ESG incorporation risks sacrificing investment returns or involves taking on additional investment risk as a means of using plan investments to promote collateral social policy goals. The counter view is that ESG issues can be economically relevant and therefore should be integral to investment decisions. This debate between collateral and integral has played out against the alternating positions of US administrations and their respective investment industry advocates.

History of ESG and ERISA policies

Since the 1980s, DOL has periodically released guidance on the applicability of the fiduciary standard to ESG investing for private retirement plan sponsors. The guidance has clarified and refined the Department’s stance on ESG investing in ERISA-regulated retirement plans and has prompted various reactions from the investment industry. The earliest guidance specified that ESG factors could only be included as a tiebreaker among equally suitable investment options. This guidance kept many private retirement plan sponsors from including ESG investment options.

However, the 1998 Calvert Letter clarified that sponsors could include ESG factors if they do not negatively affect the fiduciary requirements of diversification, liquidity, or risk and return, among other things. Some investment industry practitioners, such as Vanguard, TIAA, Social(k), and Calvert, took the guidance in this letter as permission to offer ESG investments as private retirement plan options.

Guidance from the DOL in 2015 acknowledged that ESG factors might have a direct relationship to the economic value of an investment. In these cases, DOL advised that these ESG factors can be formal components when the fiduciary analyzes competing investment options.

Throughout the years, and over multiple rounds of guidance, retirement advisors have grappled with how to square their fiduciary responsibility with investors’ growing demand for ESG investments.

“The DOL’s 2015 and 2016 interpretive bulletins identified material ESG factors as proper components of a retirement plan’s investment analysis and appropriate issues for shareholder engagement activities. The bulletins stated DOL’s stance that fiduciaries may not accept lower expected returns in pursuit of collateral benefits, which are benefits outside of investment returns. The preamble to the 2015 bulletin further explained that ESG factors can have a direct relationship to the economic value of a plan and in such a case the ESG factors are not collateral but are considered as part of the primary analysis of an investment, and the use of material ESG factors should not inherently be subject to special scrutiny. The 2016 bulletin went on to clarify that ESG factors can be appropriate topics for proxy voting policies and engagement with corporations. Both the preamble to the 2015 bulletin and the 2016 bulletin referred to the use of ESG factors by retirement plans generally and did not distinguish between how such factors may be used by defined benefit and defined contribution plans.”

2018 DOL Field Assistance

In April 2018, DOL issued Field Assistance Bulletin 2018-01, which addresses retirement plans’ use of ESG factors. The DOL again emphasized that plan fiduciaries are required to act prudently and in the best interests of beneficiaries when making investment decisions. The new field assistance bulletin generally reiterates that, in considering the use of ESG factors, plan fiduciaries are not permitted to sacrifice investment returns or take on additional investment risk in the pursuit of collateral social policy goals – a position that is consistent with DOL’s earlier guidance.

The new field assistance bulletin states that fiduciaries must not too readily treat ESG factors as economically relevant, and includes information about the use of ESG factors in engagement activities, such as proxy voting. To be consistent with ERISA and the evaluation of investment options generally, fiduciaries are required to conduct due diligence in evaluating ESG investment options in order to understand how they operate, and to assess whether such options are in the best interest of plan beneficiaries. The call for due diligence may indeed increase ESG incorporation, as it could help plans assess risks relevant to a plan’s performance that may otherwise not be assessed.