A pan-renewables organization has chastised the Department of Labor (DOL) for fast-tracking a new rule it has said is a “transparent attempt to slow the growth” of environmental, social, and governance (ESG) investing.
According to the American Council on Renewable Energy (ACORE)—a group that represents a wide range of renewables stakeholders including some of the world’s largest developers, utilities, institutional investors, and corporate buyers—the DOL’s Oct. 30-finalized rule, “Financial Factors in Selecting Plan Investments,” is redundant, and its implementation would “sow increased confusion and impose excessive regulatory burdens” on retirement and health plan fiduciaries when contemplating ESG investment decisions.
But the new rule, ACORE suggests, is just one in a series of recent actions by the Trump administration to chill ESG capital market investment. These actions are rooted in an April 2019 executive order in which the White House promoted investment in domestic energy infrastructure and sought to rebalance pension fund investment back toward traditional energy funds and projects, including for the nation’s abundant fossil fuel resources.
As the Trump administration concedes, ESG criteria has quickly evolved over the past few years into a central measure that an increasing number of utilities, investors, and corporations have adopted to gauge corporate performance, risks, and progress toward sustainability targets.
According to the Edison Electric Institute (EEI), nearly every investor-owned utility in the U.S. does “some form of ESG reporting.” To date, 44 of EEI’s member companies have set voluntary emissions reductions goals, and 24 of those companies have set net-zero or equivalent goals. The allocation of ESG funds to renewable energy investment is also often cited as a major factor that has enabled dramatic fleet-wide transformations and boosted the recent rapid uptake of renewables by an array of stakeholders, including developers, utilities, investors, and corporate offtakers.
Labor Department: Plan Fiduciaries Should Focus on Financial Interests, Not Policy Objectives
The DOL’s final rule issued Friday essentially adopts amendments to the “investment duties” regulation under Title 1 of the 1974-enacted Employee Retirement Income Security Act (ERISA), a federal law that sets minimum standards for most of private industry’s voluntarily established retirement and health plans.
Title 1 of the ERISA, specifically, governs the operation of private sector employee benefit plans. That section requires that plan fiduciaries—or trustees—act “prudently to diversify plan investments” to minimize the risk of large losses, but also to “act solely in the interest of the plan’s participants and beneficiaries.” The DOL’s amendments finalized on Friday will now require plan fiduciaries “to select investments and investment courses of action” that are “based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.”
As U.S. Secretary of Labor Eugene Scalia suggested in a press release on Friday: “This rule will ensure that retirement plan fiduciaries are focused on the financial interests of plan participants and beneficiaries, rather than on other, non-pecuniary goals or policy objectives.”
The agency said a fiduciary’s focus should remain on “pecuniary factors,” which the DOL said are “any factor” that the “fiduciary prudently determines is expected to have a material effect on risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and funding policy.”
The agency noted the amendments were necessary to clear up confusion prompted by “different iterations of sub-regulatory guidance” it had issued in the past. However, the rule also explicitly addresses “important and substantial questions about shortcomings in the rigor of the prudence and loyalty analysis by some participating in the ESG investment marketplace,” it said.
The DOL noted (citing Morningstar Research) that since 2018, assets invested in sustainable funds is nearly four times larger in 2019 than in 2018. Along with the increase in the “array of ESG-focused investment vehicles,” institutional asset managers are also increasingly using “ESG metrics, services, and ratings offered by third-party service providers.” But as ESG investing has increased, “numerous observers”—it cited the Organisation for Economic Co-operation and Development (OECD), U.S. Securities and Exchange Commission (SEC) Commissioner Hester Peirce, and three Stanford economists—have identified a “lack of precision and consistency in the marketplace with respect to defining ESG investments and strategies.”
The DOL concluded: “There is no consensus about what constitutes a genuine ‘ESG’ investment and ESG rating systems are often vague and inconsistent, despite featuring prominently in marketing efforts.” The “confusion,” it said, “stems from the fact that, from its beginning, the ESG investing movement has had multiple goals, both pecuniary and non-pecuniary.”
The DOL’s “goal is to ensure that retirement security remains the top priority of those who manage the retirement assets that millions of Americans have worked so hard to earn,” said Acting Assistant Secretary of Labor for the Employee Benefits Security Administration Jeanne Klinefelter Wilson. “Plan fiduciaries should never sacrifice participants’ interests in their benefits to promote other non-financial goals,” she said.
The final rule is expected to be effective within 60 days after publication in the Federal Register, but plans will have until April 30, 2022, to make changes to “certain qualified default investment alternatives, where necessary to comply with the final rule.”
ACORE: Recent Actions Put a ‘Thumb on the Scale’
ACORE has pushed back fiercely against this and other Trump administration rules that could affect ESG investing. Over the weekend, the organization pointedly criticized the DOL for issuing the final rule after “only 16 days of review, on a Friday afternoon, in the face of overwhelming public opposition.” ACORE also said the rule “contains no actual evidence of harm to any ERISA beneficiaries or plan participants, and explicitly affirms that [ESG] considerations can be very much material to financial performance.”
“Nevertheless, the Department persists in substituting its own preferences for the seasoned judgment of investment professionals in a transparent attempt to slow the growth of ESG investing,” said ACORE President and CEO Gregory Wetstone. “Over the long run, it won’t work. ESG investing is popular precisely because it drives superior investment performance. Rule or no rule, ESG investing is here to stay.”
Wetstone has also criticized the DOL’s Sept. 4–proposed “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights,” a separate but related rule in which the agency sought to clear up a “persistent misunderstanding among some stakeholders that ERISA fiduciaries are required to vote all proxies.”
A proxy vote is a ballot cast by an individual or firm on behalf of a corporation’s shareholder who may not be able to attend a shareholder meeting or may not want to vote on an issue. In its September proposed rule, the DOL noted a “marked increase in the size of the investment marketplace controlled by institutional investors,” as well as “a substantial change in investor voting behavior and proxy voting policies.”
One issue is that “proxy voting policies are becoming more complex, as investors continue to add to the list of factors they consider in their review and analysis of governance practices, including board independence, board accountability, diversity, myriads of executive compensation factors, shareholder rights, and environmental and social factors,” the DOL said.
According to Wetstone, however, “Grounded in the demonstrably false assumption that ESG considerations are unrelated to financial performance, the Labor Department presumes to substitute its own voting preferences for the considered judgment of seasoned investment professionals exercising one of the most basic rights of stock ownership at the heart of fiduciary duty.” The proposal “imposes needless new bureaucracy and substantial additional costs,” he said.
SEC Exploring ESG Impacts on Disclosures
Recent actions by the SEC may also forcefully impact ESG investing. The SEC’s ESG Subcommittee is spearheading that agency’s exploration of a range of potential issues, including whether ESG funds are “expressing investor values or creating value for the investor,” and how that should affect disclosures.
The SEC, notably, this March solicited public comment on whether terms like “ESG” are likely to mislead investors. And on Sept. 23, the commission voted to adopt amendments to modernize its shareholder proposal rule and effectively limit the influence small investors have over the direction of large companies. Shareholder proposals from small investors (holding $2,000 of stock) have been credited for pushing major companies to adopt strategies that are more mindful of ESG risks. In the power space, shareholder activism has focused heavily on climate risks. It was one of several factors that prompted Duke Energy, for example, to act decisively on sweeping changes to its generation mix.
But as SEC Chairman Jay Clayton noted in September, the SEC’s action to limit small investor shareholder activism focused on “a few key economic realities.” First, “in addition to the potential benefits from engagement among shareholder-proponents, companies and non-proponent shareholders, shareholder proposals impose costs on companies and on non-proponent shareholders. These costs are significant, even more so when viewed across today’s more diversified portfolios that are a hallmark of modern investing,” he said. “Second, the costs to the shareholder-proponent are low, both in absolute terms and relative to other metrics.” Finally, “in addition to a desire to improve long-term value to all shareholders, there is a risk, particularly in light of the low absolute and relative costs of submitting a proposal—in other words, the economic incentives—that shareholder-proponents would use the proposal process in a way that does not benefit the company or its other shareholders,” he said.
ESG Performance Is a Crucial Consideration
Still, for ACORE, the administration’s recent actions may not deter ESG investing, big or small, mainly owing to performance. “In 2019, ESG stocks outperformed the S&P 500 by approximately 45%. Additionally, ESG funds have been outperforming the S&P 500 during the COVID-19 crisis, according to S&P Global,” it says. However, whether ESG activities contributed to stock price resilience—and the premise that corporate social responsibility activities help to build social capital and trust in the corporation—has been disputed.
For now, at least, most stakeholders—including ACORE—agree more work may be needed to provide better methodologies to evaluate the ESG impact on investments. Urging the SEC to work on providing investors “standardized, consistent, reliable, and comparable ESG disclosures they need to protect their investments,” SEC Commissioner Allison Lee, a Trump appointee, this August emphasized: “ESG investing is no longer just a matter of personal choice.”
“Asset managers responsible for trillions in investments, issuers, lenders, credit rating agencies, analysts, index providers, stock exchanges—nearly all types of market participants—use ESG as a significant driver in decision-making, capital allocation, pricing, and value assessments,” she said. “These factors have been integrated into traditional analyses designed to maximize risk-adjusted returns on investments of all types. A broad swath of investors find ESG risks to be as or more important in their decision-making process than financial statements surpassing traditional metrics such as return on equity and earnings volatility.”