The U.S. Department of Labor’s proposal on the use of environmental, sustainable and governance (ESG) funds in defined contribution plans wouldn’t prohibit ESG options, but would encumber the selection and monitoring process and require vast levels of documentation, according to a new white paper.
The paper from Alliance Bernstein (AB), a global investment management and research firm that manages $600 billion in assets, entitled “DOL New Rules Don’t Have to Slow DC Plan ESG Adoption,” suggests the use of ESG funds would still be allowable under the rule, but that plan sponsors and fiduciaries “would need to do a lot more documenting to validate any ESG considerations on top of the current ‘all else being equal’ test.’”
The rules would also all but preclude an ESG purpose-driven fund from serving as a qualified default investment alternative (QDIA). “We think these measures are overly restrictive, which could lead sponsors to turn away from funds with any hint of ESG,” AllianceBernstein’s Jennifer DeLong, head of defined contribution, and Michelle Dunstan, global head for responsible investing, said in the white paper.
“Plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan,” the DOL postulated in the proposal, while underscoring that pecuniary considerations (in particular, financial factors) should take sole priority.
“Based on our interpretation, the DOL’s latest effort isn’t a big change from the current rules, but it may pose new challenges. The new rules wouldn’t prohibit ESG options, but they could encumber the selection and monitoring process. For example, plan sponsors would need to do a lot more documenting to validate any ESG considerations,” the authors said.
The proposal means that DC plan sponsors and fiduciaries will likely soon face new compliance challenges, while they work to accommodate the growing demand from plan participants for ESG funds.
“Shunning all ESG would be unfortunate for participants, because, as we see it, ESG considerations must be a critical component of in-depth fundamental research in any investment solution—whether it has an ESG label or not,” the AB authors said.
While the fossil fuel and manufacturing industries vehemently lobby against ESG, the authors said that companies that emit high carbon, for instance, are a perfect example of why ESG is necessary. It gives advisors and plan sponsors the ability to invest in competitors who develop low-carbon alternatives that avoid increasing carbon taxes, higher operating and legally mandated equipment costs and market risk.
“ESG considerations are financial considerations,” the AB authors said. In fact, the DOL acknowledges that ESG factors can be economic considerations if they present “material economic risks and rewards.”
“We agree: Integrating ESG can uncover issues with material financial impact, therefore making it a key contributor to plan performance by improving returns and managing risk. In our view, ignoring ESG factors leaves the puzzle unfinished and could lead to suboptimal results,” DeLong and Dunstan said.
