Asset managers are gearing up for a battle with the Trump administration over a new proposal that threatens investors’ ability to incorporate environmental, social and governance principles into pension portfolios.
Late last month, the Department of Labor proposed a new rule that would require private pension administrators to prove that they are not sacrificing financial returns if they put money in ESG-oriented investments.
“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,” said Eugene Scalia, the labour secretary.
The new rule builds on the department’s existing guidance on private pension investing, which allows investors to consider sustainability factors for the purpose of increasing returns. But the full text of the proposal has set off alarm bells across the asset management industry, where ESG-themed funds have been a big success, attracting tens of billions of dollars of investment in recent years.
Critics argue that, instead of protecting retirees from decisions that prioritise politics over returns, the rule may put them at greater risk by hindering their ability to fully analyse the companies in which they invest.
“The Department of Labor, under the current leadership, is sceptical of sustainable investing and that is bad for retirement investors,” said Aron Szapiro, head of policy research for Morningstar, the fund ratings firm.
The new rule does not prohibit sustainability analysis outright, but it restricts defined contribution pension plans from offering ESG funds as default investments — which is where many users end up, having not made an active decision on selection. It also requires fiduciaries to provide evidence that ESG-oriented investments have been chosen solely on “objective risk-return criteria.”
Mr Szapiro said: “There is no need for regulations on avoiding investments that are chosen principally to create some alternative benefit; it’s very clear you can’t do that and everyone knows that.” The strict requirements are intended to dissuade investors from “sniffing around anything that looks like ESG,” he added.
The proposal, which is open for public comment until the end of the month, stands in stark contrast to the regulations coming out of Europe, where climate risk is taking centre stage. Christine Lagarde, president of the European Central Bank, told the Financial Times this week that the ECB is exploring “every avenue available in order to combat climate change”, including through its flagship bond-buying programme.
US regulators are operating on an outdated perception of ESG, “which assumes that investors must give up performance in order to invest responsibly,” said Brendan McCarthy, head of defined contribution investments at Nuveen, a Chicago-based asset manager.
Nuveen and Morningstar are drafting critical responses to the proposal. The UN Principles for Responsible Investing, which has signed up nearly 2,300 investment managers, has also come out against the rule.
“A lot of what we do with policy and regulatory work is just to bring the facts. And in this case, we will be bringing a lot of facts,” said Amy O’Brien, Nuveen’s global head of responsible investing.
Fiduciaries looking to make the case that ESG analysis can lead to outperformance can cite a growing body of research.
Last year, Bank of America found that companies with high ESG scores generally saw lower future earnings volatility, particularly within the energy, materials, utilities and communications services sectors. The bank also found that 90 per cent of S&P 500 companies that went bankrupt between 2005 and 2015 were among the bottom cohort of ESG performers.
“We called ESG factors, in the early days, non-financial factors and we probably should have called them non-traditional factors,” said Ms O’Brien of Nuveen. “Perhaps the way that we talked about this field over the years is how we got into this current situation.”
Some argue that ESG will gain ground in pension portfolios, whether or not there are changes to the rule.
“I think that markets are driving this demand for [ESG] information regardless of where regulators or policymakers are,” said Mary Schapiro, former head of the US Securities and Exchange Commission and current board member of the Sustainable Accounting Standards Board. “Investors have determined that this is information that they need to make rational capital allocation decisions.”
But just 3 per cent of US corporate defined contribution plans offered an ESG-themed investment option in 2018, according to the most recent data from Plan Sponsor Council of America, an industry body.
Al Gore, the former US vice-president and founder of Generation Investment Management, said that the case for ESG investing was becoming harder to ignore.
“Investors who do not recognise this new reality and do not integrate ESG factors are now in serious danger of violating their fiduciary responsibility to their clients by leaving money on the table and not taking into account these factors that can actually improve performance,” he said.