The New DOL Proposal May Change the ESG Game

Melissa Kahn is Managing Director of Retirement Policy for the Defined Contribution team at State Street Global Advisors. This post is based on her SSgA memorandum.

On October 13, the Department of Labor (DOL) issued a proposal that would roll back some of the environmental, social and governance (ESG) investing rules that were finalized by the Trump administration at the end of 2020. The Trump administration rules caused uncertainty regarding fiduciaries’ ability to use ESG funds in the retirement plans that they sponsor.

The latest proposal matters because we believe that plan sponsors can more confidently incorporate ESG funds into their retirement plans if the proposal is finalized. Although the fiduciary responsibilities of ERISA plan sponsors have remained consistent in previous ESG guidance documents, [1] the continual issuance of guidance under different administrations has led to uncertainty for plan sponsors, resulting in a reluctance to include ESG funds in retirement plans. With increasing reliance on ESG factors in fund construction, we believe that plan sponsors will be closely watching the outcome of this proposal to determine whether they can incorporate ESG funds into their retirement plans in the near future.

In a departure from the Trump administration rule, the newly proposed regulation, at its core, treats ESG funds no differently than any other investment fund. Although the core tenets underlying ERISA—the duties of prudence and loyalty—remain paramount, the proposed regulation recognizes that ESG factors in investment selection can be “financially material” and clarifies that the impact of an ESG factor may be an appropriate consideration when evaluating particular investment options.

Key Points Under the New Proposal

  • The terms “pecuniary” and “non-pecuniary” have been deleted. The 2020 rule required that only pecuniary [2] factors (factors that have a material effect on risk or return) be considered in investment decisions. However, the preamble to the 2020 rule included a discussion by the DOL which cast doubt on whether ESG factors could be pecuniary. In fact, the DOL “[cautioned] fiduciaries against too hastily concluding that ESG-themed funds may be selected based on pecuniary factors.” The new proposal states that “a prudent fiduciary may consider any factor in the evaluation of an investment or investment course of action that, depending on the facts and circumstances, is material to the risk-return analysis.” The regulation goes further by including specific examples of ESG factors that may be considered.
  • Qualified default investment alternatives (QDIAs) can now consider ESG factors. The regulation issued by the Trump administration prohibited the use of funds that include “non-pecuniary” factors as QDIAs in defined contribution (DC) plans. Under the new proposal, QDIAs would be governed by the same rules of prudence and loyalty as all other investments, as well as the existing QDIA regulation.
  • The use of ESG considerations as a “tie-breaker” was clarified. Prior to the Trump era final rule, the DOL recognized that fiduciaries may consider collateral benefits as tie-breakers when choosing between investment alternatives that are otherwise equal with respect to return and risk over the appropriate time horizon. [3] At the time, ESG factors were generally considered collateral benefits. Although the tie-breaker test was retained in the 2020 regulation, the preamble stated that situations requiring the tie-breaker would be rare and imposed additional documentation requirements when it was used. Under the proposed regulation, the DOL has retained the tie-breaker test but has modified it to align more closely with the original tie-breaker standard stated in Interpretive Bulletin 94-1. Under the proposal, investments do not have to be “economically indistinguishable” for collateral benefits to be considered. Rather, a fiduciary would only need to conclude that the fund with collateral benefits “equally serves the financial interests of the plan.” Importantly, however, the DOL has clarified that ESG factors may be directly relevant to risk and return, and in those cases, would not be considered collateral benefits requiring the tie-breaker test. Although the DOL rescinded the additional documentation requirements from the 2020 rule, the new proposal requires that if the tie-breaker test is used, any collateral benefits must be prominently displayed in disclosure materials provided to participants and beneficiaries.

There is a 60-day period in which to send comments, ending on December 13.

Why This Time Is Different

With the Biden administration issuing a new regulation early in its term, rather than days or months before the end of the administration, plan fiduciaries may be able to take comfort in the fact that the legal environment will be in place for years prior to a possible change in policy. As ESG integration becomes more the norm in fund construction, we believe these factors will become one of the primary bases upon which investment managers rely.

Along with the new DOL regulation, a number of global forces are coming together that may encourage plan sponsors to move forward with incorporating ESG funds into their retirement plans. For multinational companies, regulations in Europe and the United Kingdom are not only encouraging the incorporation of ESG factors into plans’ investment lineups but requiring it.

In the US, our new survey of 100 defined benefit (DB) plans found that the importance of ESG investing has motivated many plans to increase reliance on outsourced investment management to garner increased expertise in this area. [4] Roughly 52 percent of our DB survey participants said that ESG support was the top reason for outsourcing. For DC plans, a new Schroders study [5] found that incorporating ESG investments into retirement plans may lead to greater contribution rates. The “2021 U.S. Retirement Survey,” conducted in late January 2021 among 1,000 US consumers ages 45 to 75 and 230 workers with employer-sponsored DC plans, reported that of those participants who were aware that their plan had ESG options, nine out of 10 said they invest in them. [6] The Schroder survey further found that 69 percent of retirement plan participants said they would or might increase their overall contribution rate if their plan offered ESG options.

In addition, ESG integration is gaining prevalence as a value-driving factor for traditional investment analysis and decision making. Under such strategies, the thoughtful assessment of material ESG factors—used, for example, as a complement to traditional research such as analyzing financial statements, industry trends, and company growth strategies—is integral to identifying opportunities, mitigating risks, and creating long-term shareholder value for investors. As the quality and consistency of ESG data and analytics increase, we expect such ESG integration to increasingly become a mainstream, if not standard, element of long-term, value-driven investing.


1Sub-regulatory guidance in the Clinton, Bush and Obama administrations included Interpretive Bulletins 94-1, 2008-01, and 2015-01.(go back)

2Specific references to ESG were removed from the operative language in the final regulation in 2020, but were retained throughout the preamble.(go back)

3This tie-breaker language was referenced in Interpretive Bulletin (IB) 94-1, and then again referenced in IB 2015-01 issued by the Obama administration.(go back)

4The State Street Global Advisors Corporate Pension Sponsor Survey conducted by Longitude of the Financial Times Group for the period July 2021. Survey included 100 U.S. corporate Defined Benefit sponsors with assets under management ranging from US$300 million to US$2 billion.(go back)

5The Schroders U.S. Retirement survey conducted by 8 Acre Perspective for the period January 20-27, 2021. Survey included 1,000 U.S. consumers ages 45 –75 and 230 workers with employer-sponsored DC plans.(go back)

6The Schroders U.S. Retirement survey conducted by 8 Acre Perspective for the period January 20-27, 2021. Survey included 1,000 U.S. consumers ages 45 –75 and 230 workers with employer-sponsored DC plans.(go back)

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