The Markets December 23, 2020

Biden Administration Could Bring About Changes to ESG Investing

But Republican support will be crucial for a number of President-elect Joe Biden’s proposals. 

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A new administration taking office in January could mean the rollout of highly anticipated guidance and clarity on environmental, social and governance (ESG) investing.

The effects of COVID-19 renewed interest in sustainable investing for many U.S. investors. But a proposed rule the Department of Labor (DOL) released in June seemed to put a damper on ESG investing. The department’s final rule, published in October, softened that stance somewhat, saying that retirement plan fiduciaries should only use “pecuniary” factors when assessing investments of any type.

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President-elect Joe Biden and his administration could attempt to issue guidance supporting ESG investing despite the rule, says Aron Szapiro, head of policy research at Morningstar. Because the DOL’s final rule did not specifically implement any requirements for sustainable investments, a new administration could issue sub-regulatory support for ESG funds, he says.

“The final rule doesn’t necessarily reference ESG, except in the preamble, so that suggests to me that [the Biden administration] could come up with some sort of sub-regulatory guidance to signal that it is more accommodating toward ESG investing,” Szapiro says.

A Morningstar article, which Szapiro helped write, notes that the new administration could issue such guidance in the form of frequently asked questions (FAQs) or advisory opinions, since ESG factors could be considered pecuniary and could be reviewed by plan fiduciaries as a measure of their fiduciary duty.

Ed Farrington, executive vice president of institutional and retirement business at Natixis Investment Managers, says the preamble to the DOL rule might create confusion for plan sponsors who want to integrate ESG investments into their plans. He says he expects the Biden administration will likely address the uncertainty, even without revamping the rule.

“The rule may likely stay close as is,” he says. “But pieces might be given new indications from the department, to signal to a plan sponsor that this is something that you can, and probably should, do.”

Farrington predicts the Biden administration will emphasize sustainable investing throughout the next four years. Biden’s push to rejoin the Paris Agreement, along with his goals of achieving a net-zero economy by 2050, underscore his approach on sustainability through 2024, Farrington says. “The tone that has been set—should that be followed through with policy—sets a very [foundation] for a strong trend over the coming years,” he adds.

Similarly, the Biden administration will have the opportunity to replace the outgoing Securities and Exchange Commission (SEC) chair, along with the head of the Commodity Futures Trading Commission (CFTC). A recent piece by Russell Investments notes that a new SEC chair might be tasked with requiring public companies to disclose climate change-related financial risks and greenhouse gas emissions in their operations, further enforcing a sustainable environment.

Additionally, Morningstar says there could potentially be a 3-2 Democratic majority in the SEC in the future, including the acting chair. Such a majority could revise several rules related to proxy voting rights and climate-related financial disclosures. Even if the Democratic Party does not win the two Georgia Senate runoff elections next month, many industry experts are still optimistic about the prospect of regulatory support concerning ESG investing, Szapiro says. Yet, if that’s the case, Republican support will be integral to many of the Biden administration’s goals, especially on sustainable investing.

“I think all of the commissioners recognize some sort of additional guidance” is needed, Szapiro says, “But, what would be really meaningful change will take rulemaking that I don’t think is going to be acceptable to two of the [SEC] members right now, so you really would need a fifth vote.”

Compliance December 23, 2020

A Few Important Points About the DOL’s Fiduciary Actions

Among other important developments, the Department of Labor has confirmed that one cannot simply write their way out of a functional fiduciary relationship.

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Carol McClarnon, a partner at Eversheds Sutherland, is among the many ERISA [Employee Retirement Income Security Act] attorneys who have spent the better part of the past week reading through the finalized prohibited transaction exemption (PTE) published by the Department of Labor (DOL).

For the most part, McClarnon says, the final version published by the DOL closely resembles the proposed version put forward this summer. This is to say the DOL has confirmed and formalized the return to the old “five-part test” used by the DOL for determining who is an investment advice fiduciary, while it has also finalized a prohibited transaction exemption tied directly to the Regulation Best Interest (Reg BI) standard implemented this year by the Securities and Exchange Commission (SEC).

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McClarnon says these are both important developments that bring much-needed alignment to the regulatory frameworks in place at the DOL and the SEC. She expects, however, that some uncertainty could remain in the area of rollover advice, since it is not always clear that the provision of such advice will trigger the “regular basis” element of the five-part test.

One interesting development, in McClarnon’s view, is that the DOL has confirmed that a financial professional cannot simply write their way out of a functional fiduciary relationship. This point relates to the “mutual understanding” prong of the five-part test, she explains, which stipulates that two parties’ “reasonable understandings of their relationship” are critical to determining whether they have arrived at a mutual agreement, arrangement or understanding that the investment advice will serve as a primary basis for investment decisions.

Under the new framework, written statements disclaiming a mutual understanding or forbidding reliance on the advice as a primary basis for investment decisions are not determinative, McClarnon notes. However, such statements are likely going to be relevant to the determination of whether a mutual understanding exists. The DOL has also confirmed that determining whether a mutual understanding exists could involve the analysis of marketing materials and other communications in which financial institutions and investment professionals hold themselves out as trusted advisers.

Jason Roberts, CEO of the Pension Resource Institute and managing partner at Retirement Law Group, says one important difference between the final and proposed exemption language is the inclusion of self-correction opportunities. As Roberts explains, the final prohibited transaction exemption provides a self-correction mechanism so that certain violations will not cause the loss of exemptive relief.

“A violation will not result in the loss of the exemption if the violation did not result in investment losses to the retirement investor or the financial institution made the retirement investor whole for any resulting losses,” he explains. “The financial institution must also correct the violation and notify the DOL via email within 30 days of correction.”

Self-correction further requires that the conduct at issue be addressed no later than 90 days after the financial institution has learned of the violation or reasonably should have learned of the violation. Finally, the financial institution must notify the people responsible for conducting a retrospective compliance review during the applicable review cycle, and the violation and correction must be specifically set forth in the written report of the retrospective compliance review.

Roberts says advisers were also relieved to see another change in the final framework that clarifies the recordkeeping and disclosure requirements involved here.

“Essentially, the final framework has narrowed the recordkeeping and disclosure requirements to allow only the DOL and the Internal Revenue Service to request access to related compliance documents and the files that would support compliance policies and procedures,” he explains. “Previously, plan sponsors, participants and beneficiaries could all have requested copious amounts of books and records from the regulated institutions. They can still access this information via a formal court order or something like discovery in the case of a trial—but there is no private right of action inherently to go after these documents for private investors. That’s an important development.”

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