DOL’s Final ESG Rule Appears Slightly Softer Than Proposal

The U.S. Department of Labor (DOL) has published the final version of a new retirement plan investing rule, retaining the proposed version’s formal title: “Financial Factors in Selecting Plan Investments.”

Though the title of the regulation does not suggest as much, the rule is squarely focused on addressing the use of environmental, social and governance (ESG) investments within tax-qualified retirement plans subject to the Employee Retirement Income Security Act (ERISA) and the supervision of the DOL’s Employee Benefits Security Administration (EBSA).

According to senior leaders at the DOL and EBSA, who briefed reporters on the regulation during a conference call Friday afternoon, the final version of the rule includes some important differences compared with the proposed version, though the substance of the proposal largely remains intact. By way of background, the proposed rule was published on June 30, and it generated a tremendous amount of public input during the 30-day comment period. The DOL’s website shows there were more than 1,100 unique comment letters and more than 7,000 signed form letters submitted by the investment industry and the public.

The proposed version of the rule proved to be controversial—reflected in the fact that the majority of public comments called the rulemaking unnecessary and antiquated in its hostile views of ESG investing. Many of the comment letters argued that ESG-themed investments are an important means to address the very real and quickly emerging investment challenges presented by climate change, social inequality and other major societal issues. Though it will take some time for stakeholders to digest the final version of the rule, because it does not include major changes from the proposal, it is reasonable to assume this final version will also raise the ire of ESG-investing advocates.

That being said, the final version does include some significant changes compared with the proposal, which will seemingly protect the use of ESG investing to some extent. Chief among these changes is the fact that the text of the final rule no longer refers explicitly to “ESG.” Rather, it presents a framework that emphasizes that retirement plan fiduciaries should only use “pecuniary” factors when assessing investments of any type—which is to say that they should only use factors that have a material, demonstrable impact on performance. In this sense, the rule does seem to leave ample room for the use of ESG-minded investments, presuming these types of investments are assessed in a purely economic manner and that their financial features make them prudent investments.

The preamble to the final rule, on the other hand, does speak directly to the ESG topic. The DOL and EBSA officials said the preamble seeks to help stakeholders understand how the pecuniary framework may apply to the assessment of ESG investments in practice.

Another important change emphasized by senior DOL and EBSA leaders is that the final rule does not explicitly prohibit the selection of a fund that uses ESG factors as a plan’s qualified default investment alternative (QDIA). Once again, the final rule requires that a fund being selected as the QDIA must be assessed using purely pecuniary factors that are directly material to its financial performance. Beyond this, the final rule does stipulate that a fund is not appropriate as a QDIA if its stated objectives include explicitly non-pecuniary factors—for example addressing climate change itself, rather than addressing climate change’s impact on the financial outcomes of investors.

Responding to questions from several reporters, the senior DOL and EBSA leaders said they felt the 30-day comment period was sufficient to create this final rule. They said they examined and considered each written submission to reach the final rule, noting that the DOL and the EBSA have long been engaged with the public on these topics.