ESG is more than investments; it is a philosophy or a set of principles and actions that encompasses much more. It can be a business’ desire to be greener, such as encouraging employees to recycle not only at the office but also at home. The company may also provide paid time off work to volunteer within the community, with corporate leadership fronting the way. For retirement plan purposes, ESG considerations could also include automatic plan features, such as auto enrollment, auto escalation, paperless statement delivery and the use of qualified default investment alternative (QDIA) funds.
In terms of investments, ESG has been associated with Socially Responsible Investing (SRI). This may include investing only in companies/funds that are deemed environmentally friendly and have what are considered strong corporate governance practices, and NOT investing in companies that are involved in certain industries (e.g., tobacco, alcohol, etc.). According to new regulations issued by Department of Labor (DOL), this is allowable - as long as other factors come into play first - when dealing with retirement plans.
The DOL issued proposed rules in June 2020 that specifically highlighted ESG investments, as the DOL was concerned about the significant increase in the use of ESG funds and the potential for non-pecuniary (non-financial) factors to be used in the investment decision-making process. Due to financial industry feedback provided, the DOL eased up on language specifically tied to ESG and specifically SRI in the final rule.
The final rule, published in October 2020, requires fiduciaries to look only at pecuniary factors (“… financial considerations that have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan's investment objectives and funding policy”) when determining investments to be made available to plan participants, specifically stating “… ERISA requires that both the principles of loyalty and of prudence still must be considered.” The final rule codifies prior regulations related to criteria to be used in determining acceptable investments by fiduciaries. That said, if more than one investment is being considered and all other things being equal, non-pecuniary factors, such as ESG, could be a consideration (more as a tie-breaker or a first among equals approach). If non-pecuniary factors are taken into consideration in the tie-breaker scenario, the reasons for the decision should be documented. Many organizations have specific reasons for considering the nature of ESG investment products or procedures at the organization level.
The final rule also included very specific language related to investments used as a plan’s QDIA. It states that investments used as QDIAs can only take pecuniary factors into consideration in the selection process. The main reason cited for this is to avoid forgoing financial returns in pursuit of non-financial goals. The final rule provides plan fiduciaries until April 30, 2022 to make any changes needed to a plan’s QDIA if they do not meet the specific criterial set forth by DOL.
While a company can control their ESG philosophies within the confines of their corporate structure, any decisions related to their retirement plan should be made based on ERISA regulations. This could include any entity whose plan is not required to be covered by ERISA but chooses to follow ERISA guidelines. In any event, decisions related to the plan, and how those decisions were derived, should also be documented. If you have additional questions about ESG Investing please contact us at www.cbiz.com/retirement
All quotations are from the Department of Labor final rule entitled ‘Financial Factors in Selecting Plan Investments.’
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