Advisers Get Long-Awaited Clarity on ESG in Retirement Plans

DOL's final rule clears regulatory hurdles for retirement plan fiduciaries to implement, or ignore, ESG investing.



Retirement plan advisers can finally approach environmental, social, and governance investing with clear regulatory guidance, whether they want to implement it or not.

That’s the early reaction from the industry to the U.S. Department of Labor finalizing a proposed ESG rule on Tuesday that it first floated for industry response more than a year ago. The decision allows—but does not mandate—considering ESG in retirement plans, officially overturning a rule passed under former President Donald Trump that fiduciaries only consider “pecuniary” factors when doing plan design.

“The IAA commends the DOL for its efforts to address uncertainties regarding how fiduciaries may consider ESG issues, including climate-related financial risk, in making investment and proxy voting decisions,” Gail Bernstein, general counsel of the Investment Adviser Association said in a statement. “The IAA also appreciates that the DOL makes clear that climate change and other ESG factors are often material to these decisions.”

While ESG investing has been a major focus for the asset management industry, adoption has been minimal within defined contribution plans, according to plan sponsor surveys and conversations with industry participants.

A recent survey by Prudential Financial noted that when choosing target-date funds—a retirement savings vehicle that can provide an ESG investment option— of investment advisers saw ESG integration as the least important consideration at 3% of advisers, trailing far behind the 40% who prioritize mitigating equity market sell offs.

Though uptake may be lacking, the subject of ESG has been of interest among mid-to-large plan sponsors—those with roughly $15 million to $100 million or more in assets—says Jim O’Shaughnessy, president, retirement and private wealth, HUB Midwest West.

“ESG has been a topic of discussion in almost every conversation with plan sponsors,” O’Shaughnessy says.

Discussion, however, has not necessarily led to implementation due to regulatory concerns as well as a lack of plan options in the still nascent market for ESG investing in retirement plans, O’Shaughnessy says.

“There have not been a lot of practical solutions at the plan level,” he says. “That has made it difficult for people to seriously consider getting [participants] an ESG-focused solution.”

ESG investing options are still in their “infancy,” with many questions to be worked through on how to define ESG, measure it, research it, and report it within retirement plans, O’Shaughnessy says. Solutions right now fall into a wide range of options, from an overlay of ESG on retirement investments—something provided by third-party providers such as Morningstar—or adding an ESG-driven fund in a plan menu, he notes. For now, participants are still mostly seeking education around what ESG might fit their participant pool—which can range from a focus on climate change to faith-based investment goals.

Todd Kading, CEO  of retirement plan investment manager LeafHouse Financial, says the DOL’s position in the final regulation has not substantially changed from its stance in 2018. At that stage, ESG investing could be considered so long as it was grounded in sound financial decision-making first.

LeafHouse’s Investment Sustainability Technology, or LIST, runs a quantitative analysis of investments, then a qualitative assessment, and from there narrows down to ESG-focused factors, Kading says. Through this process, he says, they are meeting the fiduciary obligations along with providing an ESG solution for the market.

“Several years ago, we recognized there was a market for ESG use in retirement plans, so we looked to meet the need,” Kading says.

The changes to the rule over recent years haven’t altered the fundamental fiduciary prudence required by the Employee Retirement Income Security Act, he notes.

This year, LeafHouse launched a new ESG-focused target date fund series with TransAmerica,  Ascensus, and Natixis Investment Managers. Kading says the DOL rule being finalized may move some advisers who have been “tepid” on ESG to consider such products. Meanwhile, for those that are “adamantly” opposed to ESG, they can rest easy knowing it won’t be mandatory to implement.

Lazaro Tiant, a sustainability investment director for North America at Schroders, said the firm was glad to see the spirit of the initial proposed guidance remained consistent in the final ruling.

“We recognize that the DOL considered a significant number of comments, and we feel that they were able to make the appropriate adjustments to provide further clarity,” Tiant said in an emailed comment. “There are also new details in the rule, such as a provision that allows for the consideration of participant preferences, highlighting a potentially significant change for retirement plans going forward. Overall, we believe that understanding the nuances of ESG-related factors helps give investors a fuller perspective of risk and return.”

A Securities and Exchange Commission announcement on Tuesday highlighted the continued need for clarity around ESG investing generally. The SEC said they charged Goldman Sachs Asset Management for failures in correctly incorporating ESG research in investment procedures.

“Personnel completed many of the ESG questionnaires after securities were already selected for inclusion and relied on previous ESG research,” the SEC said.

Goldman settled the charges with a $4 million penalty, the SEC said.

O’Shaughnessy of HUB anticipates more conversation with plan sponsors next quarter after they’ve all had the chance to process the final rule being in place.

Widespread implementation of ESG into DC plan fund lineups, however, is likely still further out he says. Take, for example, the fact that energy stocks—including fossil fuels—were often better performers during the market downturn over the past year. If an ESG strategy is “underperforming a benchmark because it’s excluding specific asset classes,” he says, it would be a challenge to provide it as a fiduciary, he notes.

“Clients will probably want to wait and see for awhile to let the marketplace mature a little bit,” he says. “If things stick, and with additional Q&A, some clients will take action with it over time.”

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