Department of Labor Issues New Guidance on ESG
*Note, this article originally appeared in MSP’s newsletter: ESG in Private Equity Quarterly, published December 16th, 2015. To sign up for MSP’s quarterly newsletter, visit our contact page.*
After Seven Years, the Department of Labor Changes Guidance on ESG for Pension Plan Fiduciaries
In a reversal of its previous interpretive bulletin, the US Department of Labor (DOL) clarified that environmental, social, and governance issues “may have a direct relationship to the economic and financial value” of a pension plan’s investments and that they should be “proper components of the fiduciary’s primary analysis.” The October 22nd bulletin marks an important turning point in US policy regarding ESG and should invite further expectations onto fund managers and their investments.
The Employee Retirement Income Security Act of 1974 (ERISA) was established to protect individuals covered by private sector benefit plans. As of October, plans under ERISA covered “about 143 million workers and their dependents and include assets of over $8.7 trillion.” (DOL) Reporting, disclosure, vesting, participation, funding, fiduciary conduct, and enforcement is administered by the DOL and its subsidiary, the Employee Benefits Security Administration (EBSA).
In a controversial 2008 investment bulletin, the EBSA indicated that a pension plan fiduciary under ERISA should consider ESG issues and economically targeted investing (ETI) as “collateral, non-economic factors.” Furthermore, the bulletin indicated that if a fiduciary were to consider ESG issues in investment decisions, he or she had to document the positive benefit of such a decision in a manner compliant with ERISA’s fiduciary standards. In its October bulletin, the EBSA acknowledged that the 2008 guidance “unduly discouraged fiduciaries” from considering ESG in investment decisions. The new interpretive bulletin clarified that ESG issues “are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.”
The decision was widely expected and lauded by responsible investment professionals. “Today’s action enables investment professionals to exercise their judgment and expertise in the service of beneficiaries without concerns about possible conflicts with ERISA,” said the Forum for Sustainable and Responsible Investment (US SIF) CEO Lisa Woll.
In many ways, the new DOL guidance is simply catching up to where most investors and fund managers currently stand on ESG. In MSP’s 2015 ESG in Private Equity report, it found “that a majority of firms now recognize ESG risks and opportunities as material to a portfolio company’s value.” While the ERISA guidance comes closer to meeting this approach, it marks an important point in US public policy on ESG issues. Analysts point to ERISA’s “prudent man” rule in 1976 which formed the basis for venture capital investing and spawned a boom in VC entrepreneurship. As with that decision, the formalization of policy on this issue may spawn a boom in economically targeted investments and consideration of ESG issues.
Fund managers today expect that nearly every potential investor will inquire on ESG, led by the strongest calls from European and US public pension plans. Those in the market over the next year can expect to see increased and sustained expectations from investors governed under ERISA who no longer need fear reproach in consideration of ESG issues.