Soon after taking office, President Biden issued an executive order requiring federal agencies to review policies or regulations issued by the prior administration that were inconsistent with the new Administration’s climate change, health, and labor policies.
In October 2021, the Department of Labor (DOL) completed its review and published proposed rules (the “Proposed Regulations”) that would significantly change specific regulations it issued at the end of 2020. The DOL found that the regulations could have a “chilling effect” on fiduciaries from making investment decisions or exercising shareholder rights that furthered the Administration’s policies.
Once finalized, the Proposed Regulations could remove hurdles encountered by fiduciaries when making investment decisions that consider climate change or other environmental, corporate governance, or social (ESG) factors.
Fiduciaries of ERISA plans are required to make prudent investment decisions that are based exclusively on the interests of plan participants and beneficiaries. Thus, the law does not permit fiduciaries to make investment decisions that sacrifice an expected investment return for other policy goals of the fiduciary.
Prior to 2018, the DOL issued interpretive bulletins over ten years to clarify how fiduciaries may consider ESG factors for plan investments. These bulletins consistently found that plan fiduciaries may consider ESG factors to the extent that a prudent fiduciary finds them relevant to the risk/return analysis of a particular investment or as a “tie-breaker” among investments that are otherwise indistinguishable in terms of risk/return analysis.
However, the interpretive bulletins did not provide a consistent framework on how fiduciaries should apply these principles. For example, Interpretive Bulletin 2015-1 found that fiduciaries are not prevented from the “consideration of collateral benefits, such as the benefits offered by a ‘socially responsible’ fund” as an option for any investment. Yet, Interpretive Bulletin 2018-01 warned that fiduciaries should “not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision.”
At the conclusion of its review, the DOL found that its 2020 regulations may have a “chilling effect” on consideration of ESG factors and require modification. The Proposed Regulations authorize fiduciaries to consider all facts and circumstances that they determine to be material to the risk-return analysis, and specifically reference the following as examples:
- Climate change-related factors, such as a corporation’s exposure to economic effects from climate change or governmental regulation addressing climate change;
- Corporate governance factors, including board composition, executive compensation, and transparency; and
- Workforce practices, including diversity and inclusion and labor relations.
The Proposed Regulations state that these examples are intended to be “no different” than any traditional risk/return factors and should be considered in evaluating a particular investment only when a fiduciary prudently determine that they are material to the risk/return analysis.
Nonetheless, the DOL is welcoming comments on whether fiduciaries should consider climate change as “presumptively material” to an investment’s analysis and the extent to which climate-related financial risk is not already incorporated into market pricing. As a result, any final regulations may expand on these principles and mandate a climate change analysis as part of an investment review.
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