On October 13, 2021, the Department of Labor (DOL) released a new proposed regulation under ERISA that would replace the previous administration’s “pecuniary factors” rule – which is widely seen as discouraging the use of environmental, social and governance (ESG) factors when selecting plan investments – with one that would encourage their consideration and provide a clearer path for plan trustees to do so.


Over the years, the DOL’s stated stance on taking ESG and other “social” factors into account when selecting plan investments has shifted both ways, largely based on biases.

On the one hand, the Democratic and Republican administrations have always agreed on two fundamental principles:

  • First, trustees cannot subordinate the economic interests of plan participants – that is, they cannot accept lower returns or higher risks – in order to serve independent social policy objectives.
  • Second, trustees can nonetheless “sever the ties” between otherwise equivalent investment options by viewing social factors as secondary considerations.

However, boards of Republican administrations have generally adopted a cautious tone, stressing that the tie-breaking scenario should only occur infrequently, and expressing concern that the trustees may therefore violate their legal duty of loyalty to plan members. by choosing too ardently ESG Investments. Democratic guidance has been more permissive on this point, and a 2015 newsletter published under the Obama administration went further – not only endorsing the use of social factors to sever ties, but also considering them as economic considerations. “Main” when they would. should influence the risks and returns of investments.

Historically, these positions have been articulated in competing interpretation bulletins and similar guidelines, which do not have the legal force of formal regulation, with subsequent administrations continually “reinterpreting” those of their predecessors across the country. the aisle. The previous administration was the first to embark on a formal regulatory process on the subject, which culminated in the finalization of the final “pecuniary factors” regulation in November 2020, with a general effective date of January 12, 2021. In order to make changes to the finalized regulation, the current administration also had to engage in a formal regulatory process.

Status of the pecuniary factors rule

The currently applicable “pecuniary factors” rule – although not drafted as a statement specific to ESGs – was nonetheless generally viewed as unfavorable to ESGs. To be clear, it does not preclude the consideration of ESG factors or the selection of ESG investments. Rather, the general idea of ​​this current rule is simply that investments should generally be selected only on the basis of factors considered by the Trustees to be of a pecuniary (economic) nature. Thus, it does not prohibit (or at first glance even necessarily discourage) the consideration of ESG factors insofar as they are used as part of the risk / reward analysis, rather than for attributes. unrelated social.

However, some substantive aspects of the “pecuniary factors” rule and its preamble commentary can be interpreted as indicating that ESG investments may be subject to special scrutiny. He has also been criticized for setting unclear standards that are difficult to reliably apply in practice. As summarized by the DOL in the publication of its new rule proposal:

[the current rules] have created uncertainty and have the undesirable effect of discouraging the consideration by ERISA trustees of climate change and other ESG factors in investment decisions, even in cases where it is in the market. financial interest plans to take such considerations into account. This uncertainty may deter fiduciaries from taking actions that other market investors are taking to improve the value and performance of investments, or improve the resilience of the investment portfolio to the potential financial risks and impacts associated with climate change and other ESG factors. (Emphasis added)

Even before the publication of its proposed new rule, the pecuniary factors rule met with resistance from the current administration, with the DOL even making the unusual decision of declaring that it would not apply it (this would happen). is produced in March 2021 and is discussed in our previous Spotlight on the benefits Publish). The proposal would modify the current pecuniary factors rule in several respects, the most important of which are:

Taking ESG factors into account – Duty of care

First, and probably more fundamentally, the proposal would provide that a fiduciary’s duty of care in assessing projected returns on investments “may often” require consideration of the economic effects of climate change and other ESG factors. . He adds that a prudent trustee may consider all important factor for a risk-reward analysis, and offers three categories of considerations that might be relevant for such an analysis – to summarize:

  • Factors linked to climate change, including both direct exposure to climate change risks as well as the effects of government policies aimed at mitigating climate change;
  • Governance factors, including “the composition of the board of directors, executive compensation, transparency and accountability in corporate decision-making”, as well as compliance with applicable laws and regulations; and
  • Workforce practices, including diversity and inclusion, investments in training, equal employment opportunities and labor relations.

These categories are presented in the form of a non-exhaustive list of examples. This part of the proposal clarifies the DOL’s current view that ESG and similar considerations should often be considered as authentic economic considerations, and not just collateral factors. And while the wording of the proposal is generally flexible, it goes beyond simply ‘allowing’ the consideration of these types of factors, and rather indicates that they are likely to be considered. should be taken into account, at least in many cases.

“Breaking ties” – Duty of loyalty

Second, the proposal retains the concept that while trustees cannot subordinate the interests of plan members to social or other goals, “collateral benefits” can still be used to sever ties.

Specifically, the proposal states that trustees must first engage in a prudent risk-return analysis which may take into account the types of ESGs and related factors mentioned above. In doing so, the weight given to a particular factor should reflect a careful assessment of its impact on the risk / reward ratio. Following this analysis, if the Trustee concludes that several options available would be “also serve the financial interests of the plan over the appropriate time horizon, The collateral benefits can then be used to choose between them. For designated investment alternatives made available to participants under 401 (k), 403 (b) or other participant-driven regimes, it is necessary that the collateral considerations used to break the tie be “Apparently highlighted” in information materials provided to participants. It should be noted that, when the Trustees conclude that ESG factors should improve returns, reduce risk, or both, they are not simply used as a tie-breaker and this special disclosure does not appear to be required.

These provisions differ from the current rule in several respects. Probably the most important:

Under the current rule, trustees are only allowed to use non-pecuniary factors to sever ties between potential investments when they are “”unable to distinguish on the basis of pecuniary factors alone. “Because no two investments are the same (regardless of ESG considerations), the ‘inability to distinguish’ test has been criticized as unrealistic and unclear in its application in the real world.

Likewise, the proposal would remove the special documentation requirement imposed under the current rule when non-pecuniary factors are used to sever ties, which the current DOL has criticized as creating unnecessary burdens and

mistakenly suggesting to some fiduciaries that they should be wary of ESG factors, even when those factors are financially important to the investment decision.

ESG considerations for QDIAs

Again, the “pecuniary factors” rule does not preclude the use of ESG considerations when selecting investment options for 401 (k), 403 (b) and other corporate-led regimes. participants (or any plan). However, it specifies that Qualified Default Investment Alternatives (QDIA) cannot include any investment vehicle if

its investment objectives or goals or its principal investment strategies include, consider or indicate the use of one or more non-monetary factors.

To paraphrase briefly, the previous administration’s rationale for this provision was that default investments warrant special treatment, as they are not simply offered to participants as an additional investment alternative in a wider range among which they will make. a selection. However, this restriction has been criticized as creating a level playing field, even for performing investment options, only depending on whether they exhibit (or even appear to have) ESG characteristics.

The proposal, if finalized in its current form, would abolish the special QDIA rule and instead apply the same standards – including those summarized above – that are to be used for the selection and monitoring of all investments.

Comments on the proposed regulation must be submitted no later than December 13, 2021, or 60 days after it was posted (which took place on October 14, 2021) in the Federal Register. Of course, it cannot be finalized until the public comment and other rule-making processes are complete. However, if the proposal is finalized in its current form (or something close to it), that will represent a very significant policy change. In our experience, and in particular in light of the DOL’s policy of non-application of the pecuniary factors rule of the previous administration, there has been no massive exodus of ESG investments by the regimes. of retirement. However, if finalized, the proposed rule would provide additional comfort and guidance to trustees and confirm that ESG and similar considerations should be viewed as fundamental economic considerations.

The proposed rule would also make some changes to the existing standards for proxy voting by plan trustees, which we will discuss in a separate chapter. Spotlight on the benefits Publish.

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