ESG Rule - Tyrannical or Enabling?

Nowadays, many people are talking about ESG, which stands for environmental, social, and governance factors, and how they should be considered when choosing investments. Often, ESG is used as a proxy for a particular issue and not the collection of factors that is implicit in the name. Every investor has their own opinions based on their experiences, and they can choose to invest in things that align with their values and avoid those that don't, although they may have limited options like their employer's 401(k) plan. The current ESG Rule, recently upheld by President Biden through veto, enables employers to, but does not mandate, consideration of economic impacts of ESG factors and participant preferences.

In 2020, the Department of Labor (DOL) issued an administrative rule titled that restricted ERISA plan fiduciaries from considering non-financial factors, including participant preferences, in selecting plan investments. In 2022, the DOL, now under the Biden administration, replaced that rule with it's own rule. This revision freed up plan fiduciaries to exercise their own judgement in determining what factors are relevant to consider in assessing the risk/return profile of investments. This new rule overtly referenced the potential economic effects of climate change and other ESG factors as considerations a plan fiduciary may take into account. The preamble of the 2022 rule also recognized that having investments that align with participant preferences may lead to greater participation and higher deferral rates, which could lead to greater retirement security. Rather than forcing a political initiative on your 401(k) plan savings, this rule affords fiduciaries more flexibility while retaining the long-standing duties of prudence and loyalty.

Under the current rule, if aligning investments with participant preferences would reasonably be expected to increase plan participation and savings rates, and the selection of such investments is otherwise consistent with their fiduciary duties:

• Christian organizations whose workforce expresses a desire for biblically responsible investments may be permitted to include such options in their retirement plan;

• Companies with a workforce striving to protect the environment may be able to divest their 401(k) of investments that don't share their commitment to be environmentally conscious; and

• An accounting company that believes strong controls and corporate governance practices are good proxies for how well a company is run may choose to consider that as part of their investment policies.

These decisions which are grounded in shared workplace values would have been questionable, at best, under the 2020 rule. The current ESG rule does not, by itself, tilt investments toward companies that help reduce global warming or towards those that refuse to embrace identity politics Rather, it enables plan fiduciaries to conduct analysis and draw conclusions that provide their employees the greatest financial benefit for the least risk, which could look different for every company.