ESG Investing Enters 'New' Paradigm

The Department of Labor issued Interpretive Bulletin 2015-01, a piece of guidance Labor Secretary Thomas Perez says will significantly expand the use of environmental, social and governance (ESG) investing principles under the Employee Retirement Income Security Act (ERISA).

Speaking to reporters in New York City, Perez said the new guidance essentially returns the ESG investing paradigm back the way things worked between 1994 and 2008. Rather than ESG, Perez and DOL favor the term ETI, short for economically targeted investments.

“We’re talking about the same thing here when we say ESG, SRI or ETI,” Perez explained. “Whatever term you favor, ETIs are investments that are selected for the benefits they create in addition to the investment return to the employee benefit plan investor.”

The new guidance is meant “to return us to a common sense approach,” Perez said, by reestablishing principles first introduced under Interpretive Bulletin 1994-1 (IB 94-1). His explanation of the need to repeal Interpretive Bulletin 2008-1, which up until today provided the most direct guidance on ESG issues for retirement plan fiduciaries, was particularly derisive and highlighted the influence of President Obama’s politics in the DOL’s ongoing rulemaking. Perez took veiled shots at both formal DOL officials and President George W. Bush specifically for pushing through a rule “in search of a problem.” He said the DOL under Bush unnecessarily put the brakes on ESG investing for no good reason and has left the qualified retirement planning space “a decade or more behind other segments of the investing markets when it comes to ETI.”

But the press conference was overwhelmingly positive in tone, also featuring a lineup of industry executives all throwing their support behind the new guidance. Organizations represented included Morgan Stanley, Trillium Asset Management, the Service Employees International Union and the Forum for Sustainable and Responsible Investment, among others. 

“We all believe investing in the best interest of a retirement plan and in the growth of a community can go hand in hand,” Perez said. “We have heard from stakeholders that a 2008 department interpretation has unduly discouraged plan fiduciaries from considering economically targeted investments. Changes in the financial markets since that time, particularly improved metrics and tools allowing for better analyses of investments, make this the right time to clarify our position.”

NEXT: What the new (old) rules dictate  

As Perez explained, the Labor Department previously addressed issues relating to ETIs in Interpretative Bulletin 94-1. The publication “corrected a misperception that investments in ETIs are incompatible with ERISA's fiduciary obligations” that existed beforehand, Perez said. The guidance also, according to Perez, “contains much clearer discussion and explanation of how responsible fiduciaries should and should not use ESG/ETI factors while creating and managing portfolios under ERISA.”

Strictly speaking, under IB 94-1, as under the 2008 guidance, ESG investing factors can still only serve as a tiebreaker when considering economically similar investments. As Perez clearly reiterated, “Fiduciaries still may not accept lower expected returns or take on greater risks in order to secure collateral benefits.”

But under the 94-1 paradigm, unlike under 2008-1, the DOL directly acknowledges that environmental, social, and governance factors “may have a direct relationship to the economic and financial value of an investment. When they do, these factors are more than just tiebreakers, but rather are proper components of the fiduciary's analysis of the economic and financial merits of competing investment choices.”

This is a exactly the solution to the ESG Catch 22 that the industry said it was lacking. As the preamble to the 94-1 guidance states, the requirements of Sections 403 and 404 of ERISA “do not prevent plan fiduciaries from investing plan assets in ETIs if the ETI has an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics that are available to the plan, and if the ETI is otherwise an appropriate investment for the plan in terms of such factors as diversification and the investment policy of the plan. Some commenters have referred to this standard as the ‘all things being equal’ test.”

Perez said the new interpretative bulletin “does not in any way supersede the ‘investment duties’ regulatory standard at 29 CFR § 2550.404a-1, nor does it address any issues that may arise in connection with the prohibited transaction provisions of ERISA.”

“Rather, IB 2015-01 confirms the department's longstanding view that plan fiduciaries may invest in ETIs based, in part, on their collateral benefits so long as the investment is appropriate for the plan and economically and financially equivalent with respect to the plan's investment objectives, return, risk, and other financial attributes as competing investment choices,” Perez said.

NEXT: Industry response quick and positive  

A variety of retirement plan service providers and industry lobbying organizations quickly voiced support for the new regulation on Thursday, including some who helped Perez introduce the new language.

Speaking after Perez introduced Interpretative Bulletin 2015-01, Audrey Choi, CEO of the Morgan Stanley Institute for Sustainable Investing, said her firm is thrilled to see the DOL emphasizing the importance of ESG investing factors and their compatibility with ERISA.

“Prudent investors want to make investment decisions using as much materially relevant information available to them as possible,” she said. “Our work at Morgan Stanley has found that a large number of investors want to invest for both social impact and financial return, and today’s announcement will enable Americans saving for retirement to more easily do exactly that.”

Lisa Woll, CEO of the U.S. Forum for Sustainable and Responsible Investing (US SIF), agreed with that assessment and said the many members of her advocacy organization share almost universal support for the direction the DOL is moving with this rulemaking. “Today’s action will enable investment professionals to exercise their judgement and expertise in the service of beneficiaries without concerns about possible conflicts with ERISA,” she said.

One US SIF member firm present at the press conference was Trillium Asset Management. The firm’s CEO, Matthew Patsky, agreed wholeheartedly with Woll and said ESG factors have long helped his firm identify “highly compelling long-term investing opportunities.” He said the firm already serves some retirement plan clients but looks forward to doubling down on bringing ESG investing to retirement plan participants.

“What makes this an even more appropriate decision today is that the quality of analysis and real-time analytics around ESG factors has just improved so dramatically since 2008,” Patsky said. “It's an entirely different world from that perspective.”

Before concluding the press conference, Perez hinted at the potential for more upcoming guidance in this area. In 2008 there was a sister bulletin issued alongside 2008-1, known as “Interpretative Bulletin 2008-2,” which deals with related questions concerning when it is appropriate for retirement plan participants and sponsors to operate as “shareholder activists”—using plan assets to influence the way companies or industries are managed. These questions get into a similar analysis as the current ETI reform, Perez said, and so the DOL is actively looking into revising 2008-2.