Too many hurdles and too much red tape on ESG investments: Etica Funds signs a letter to the US Department of Labor

Too many hurdles and too much red tape on ESG investments: Etica Funds signs a letter to the United States Department of Labor (DOL).

DOL’s ESG investment proposal

The DOL presented a guideline that aims to clarify the application of fiduciary duties of prudence under the 1974 Employee Retirement Income Security Act (ERISA) for ESG investments within pension plans. Labor Secretary Eugene Scalia explained the rationale of the new rule: “Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan”.

ERISA sets out the minimum standards governing the operation of pension plans for private-sector employees: it requires trustees to execute plans exclusively in the interest of participants and beneficiaries for the sole purpose of providing benefits and paying the plan expenses, with care and prudence.

The rule proposed by the Department of Labor is designed to clarify that ERISA plan trustees cannot invest in ESG investments if, in doing so, the risk-adjusted return is reduced for non-financial purposes.

Weaknesses of the DOL proposal

In the opinion of the main SRI networks of which Etica is a member (in particular PRI and ICCR), the proposal under discussion would introduce burdensome bureaucratic and compliance requirements. The result of the proposal would be to create an obstacle to ESG investment and to discourage US institutional investors from offering ESG funds.

In particular, according to the PRI network, the proposal is confusing, improvised and serves to incorrectly characterise ESG integration as an asset class rather than a prudent way of managing risk, relevant to all asset classes. Furthermore, adds the PRI, regulators in major markets in the rest of the world ask fiduciary investors (e.g. pension funds) if and how their investments consider ESG factors; the rule proposed by the DOL, however, represents a significant step in the opposite direction.

The ICCR’s view

The ICCR network prepared a comment letter explaining why the DOL should withdraw this proposal, specifying its adverse effects on ESG investments and the lack of adequate economic justification and cost/benefit analysis.

The main points identified by the ICCR concern the following aspects:

• The proposal does not provide clear rules on when fiduciaries could choose ESG investments based on prohibited factors (e.g. not linked to pecuniary benefits). Instead, it states that fiduciaries “may” make decisions on inadmissible grounds and that investment products “may” be marketed to fiduciaries based on non-pecuniary benefits. No support is provided to clarify these claims.
• The proposal ignores the fact that investment managers may view ESG integration as appropriate and in line with fiduciary and financial considerations. Many studies show a positive correlation between ESG integration and financial results.
• The definition of when ESG factors are considered irrelevant from a financial perspective is very limited, particularly given the growing evidence of a connection between these factors and financial performance. Research in this area is ongoing and rapidly evolving, and the DOL should not require fiduciaries to demonstrate that the ESG factors they consider are deemed to be material within the framework of “generally accepted investment theories”, as such theories may not be up to date or in step with the times.
• It is not clarified when an investment option of a defined-contribution plan is deemed to include ESG assessments in its investment mandate. Many fund and portfolio managers integrate ESG considerations when making investment and voting decisions, even if they do not explicitly state that they are favouring ESG-like results or following a specific ESG approach. The DOL should clarify that the proposed rule does not apply in such cases.

For more information, see the full text of the ICCR comment letter.

Why did Etica sign?

The signing of the letter was deemed consistent with Etica’s mission to promote sustainability within the national and international financial community.

The signing is also another engagement activity carried out by Etica with regulators and governments, in addition to other initiatives such as the OECD letter on the commitment to tax transparency and the open letter to EU leaders for concrete sustainable development actions after the COVID-19 emergency.