DOL Alert: Proposed Regulation on ESG Investing and Shareholder Rights
The Department of Labor (DOL) is preparing to finalize a proposed rule that changes the way environmental, social and governance (ESG) factors are viewed in a plan sponsor’s investment process and proxy voting methods. The proposal, which was issued in October 2021, aims to help plan sponsors understand their responsibilities when investing in ESG strategies and makes significant changes to two previously issued ESG rules.
Here, we provide an update on the DOL’s proposed rule and seek to help plan sponsors understand their potential new responsibilities when considering ESG investments.
Background on ESG rules
For many years, the DOL has considered how non-financial factors, such as the effects of climate change, may affect plan sponsors’ fiduciary obligations. Amid an increasing focus on ESG investments, the Trump administration issued a final rule on ESG in November 2020 that required plan fiduciaries to only consider financial returns on investments—and to disregard non-financial factors like environmental or social effects. The rule also banned plan sponsors from using ESG investments as the Qualified Default Investment Alternative (QDIA).
A separate ruling issued in December 2020 said that managing proxy and shareholder duties (for investments within the plan) should be done for the sole benefit of the participants and beneficiaries—not for environmental or social advancements. It also stated that fiduciaries weren’t required to vote on every proxy and exercise every shareholder right.
In March 2021, the Biden Administration said it would not enforce the previous year’s rulings until it finished its own review. The current proposed rule is the result of that research.
Overview of the new proposed ESG rule
In October 2021, the DOL proposed a new rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” According to the proposed rule, fiduciaries may be required to consider the economic effects of climate change and other ESG factors when making investment decisions and exercising proxy voting and other shareholder rights. The proposal states that fiduciaries must consider ESG issues when they are material to an investment’s risk/return profile. The rule also reversed a previous provision on QDIAs, paving the way for ESG investment options to be used in automatic enrollment as long as such investment options meet QDIA requirements.
The new ESG rule also made several changes to fiduciaries’ responsibilities when exercising shareholder rights. First, it changed a provision on proxy voting, giving fiduciaries more responsibility in deciding whether voting is in the best interest of the plan. Second, it removed two “safe harbor” examples of proxy voting policies. Next, the proposed rule eliminated fiduciaries’ need to monitor third-party proxy voting services. Lastly, the proposal removed the requirement to keep detailed records on proxy voting and other shareholder rights.
In addition, the DOL updated the “tie-breaker test” to allow fiduciaries the ability to choose an investment that has separate benefits (e.g., ESG factors) if competing investments equally serve the financial interests of the plan.
Comment letter analysis shows broad support for the proposed rule
The DOL received more than 22,000 comment letters for the proposed regulation. Ninety-seven percent of respondents support the proposed changes according to an analysis of the comment letters by the Forum for Sustainable and Responsible Investment (US SIF), a membership association that promotes sustainable investing. While some respondents asked the DOL to revisit the tie-breaker provision and other specifics of the proposed rule, many respondents agreed that the proposed rule clears the way for fiduciaries to consider adding ESG investment options to benefit plans.
BDO Insight: Consider how the proposed ESG rule affects your plan today
Based on the typical timeline for similar rule changes, the DOL is expected to issue its final version of the proposed rule by mid- to late-2022. This means that plan sponsors shouldn’t have to wait long for clarification on their ability to add ESG investments to their plans. To prepare for the potential changes, plan sponsors should review the proposed rule and consider creating a prudent selection process that reviews all aspects that are relevant to an investment’s risk and return profile. As always, documentation is a critical step in this process.
Your BDO representative is available to help review the DOL’s proposed stance on ESG factors and help you understand the options available for your plan and its participants.
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