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October 28, 2021

ESG Investments by Retirement Plans: Proposed DOL Regulations Could Pave the Way


The United States Department of Labor (DOL) released proposed regulations on October 14, 2021 that could lead to an increase in investments by pension and other ERISA plans in ESG-focused funds. Under the proposed regulations, plan fiduciaries might, in some circumstances, be able to take into consideration climate change and other environmental, social and governance (ESG) factors when making investment decisions without violating their duties of loyalty and prudence. The proposed regulations follow the Biden Administration’s announcements that it would not enforce the existing DOL regulations issued during the Trump Administration that were viewed as limiting the ability of plan fiduciaries to invest plan assets in ESG-focused funds (the 2020 ESG regulations). (Note: We previously issued advisories on the January 20, 2021 DOL announcement and the March 10, 2021 DOL announcement.)

As a reminder, the 2020 ESG regulations generally (a) required plan fiduciaries to select investments based solely on consideration of “pecuniary factors,” (b) required additional documentation if plan fiduciaries considered nonpecuniary factors as “tie-breakers” between investment alternatives that were indistinguishable based on pecuniary factors alone and (c) prohibited plan fiduciaries from selecting ESG-focused investments as qualified default investment alternatives (QDIAs) for a plan.

The proposed regulations broadly permit a plan fiduciary to take into account ESG factors and select ESG-focused investment alternatives in the discharge of its duties of prudence and loyalty. Specifically, the preamble notes that a purpose of the proposed regulations is to reduce uncertainty that may deter plan fiduciaries from taking steps that other investors may take in “improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors.”

Some key differences between the proposed regulations and the 2020 ESG regulations are summarized below.

  • The proposed regulations eliminate the prohibition on considering nonpecuniary factors when selecting investments or an investment course of action. The proposed regulations explicitly state that a prudent fiduciary may consider any factor that is material to the risk-return analysis, including:

    • Climate change-related factors, such as a company’s exposure to the real and potential economic effects of climate change;
    • Governance-related factors, such as board composition, executive compensation, and transparency and accountability in company decision-making, as well as a company’s avoidance of criminal liability and compliance with applicable laws and regulations; and
    • Workforce-related practices, such as a company’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion and retention, its investment in training to develop its workforce’s skill, equal employment opportunity, and labor relations.
  • The proposed regulations reflect the current DOL’s view that ESG factors may have a material, pecuniary impact on the risk-return analysis over the time horizon relevant to plan investment. However, consistent with longstanding DOL guidance, the proposed regulations do not allow a fiduciary to sacrifice investment returns or take additional investment risk to promote benefits or goals unrelated to the interests of the participants and beneficiaries in their retirement income.
  • The proposed regulations eliminate the 2020 ESG regulations’ prohibition on selecting an ESG-focused investment as a QDIA.
  • The proposed regulations return the “tie-breaker” standard under which fiduciaries can take into account collateral benefits of investments to DOL guidance issued prior to the 2020 ESG regulations to provide that collateral benefits of the investment returns (including ESG factors) may be considered if competing investments “equally serve the financial interests of the plan over the appropriate time horizon,”
  • The additional documentation requirements under the 2020 ESG regulations for considering nonpecuniary factors would be eliminated; however, fiduciaries of participant-directed individual account plans must prominently disclose the collateral-benefit characteristic of the investment option (including a QDIA) in materials provided to participants and beneficiaries (which may be incorporated into existing disclosures).

The proposed regulations represent the current administration’s affirmation that plan fiduciaries make decisions based on the financial interests of plans, while providing plan fiduciaries with increased flexibility to evaluate and select ESG-focused investments. The comment period for the proposed regulations ends on December 13, 2021, after which the DOL will review the comments and make any changes before issuing the final rule. The proposed regulations will be of significant interest to all involved with retirement plan investments, including plan fiduciaries, investment advisors, investment managers, fund sponsors, and other entities offering investment funds. Arnold & Porter will monitor and report on any updates.

© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.