ImpactAlpha, July 23 –Investors may debate the merits of competing sustainability frameworks, or which environmental or social factors are truly material to corporate performance, or how fast they can align their assets with the 2-degree scenario called for in the Paris climate agreement.
But a wide swath of investors appear united in pushing back against a proposal from the U.S. Department of Labor that would make it so onerous to offer environmental, social and governance, or ESG, options in retirement accounts as to effectively ban them.
Contradictory. Contemptuous. Fatally flawed. These are just a few of the adjectives they have used to describe the proposed rule.
The new rules would affect, directly and indirectly, a huge sum of capital. Americans held $28 trillion in retirement plans at the end of the first quarter. Globally, some $40 trillion in assets are managed using some kind of ESG focus. Capital flows into ESG-focused ETFs and mutual funds, which set records in 2019, have continued this year, even as withdrawals from other funds have increased. More than $15 billion flowed into ESG investment products in the first six months of the year, topping earlier records, according to ETF Flows.
“There are a bunch of myths about ESG – that it costs more, that it’s concessionary, that it’s somehow apart from the mainstream,” said Sinclair Capital’s Jon Lukomnik, who has written a widely endorsed letter to the Department of Labor. “By having someone roll all of those bogey-people into one room, it has rallied everyone.”
“This is the classic common enemy,” he told ImpactAlpha. “Everyone is united against this.”
With an unusually short 30-day comment period, investors, asset managers and retirees have scrambled to register their opposition to the proposed changes. In another departure from tradition, the Department of Labor has declined to make the comments public. To assist each other in responding, investors have organized Zoom calls and shared their comments widely to encourage additional responses.
Comments (identified by RIN 1210-AB95) can be submitted to www.regulations.gov through July 30.
The rule “fails as a matter of process, substance, cost-benefit analysis, regulatory policy, economics, consistency with other Administration policy, and clarity,” corporate governance pioneers Nell Minnow and Bob Monk wrote in their own letter to the Department of Labor. They cite the “great deal of evidence about the increasing sophistication of institutional investors in using ESG indicators to evaluate risk and return and the increasing importance of those factors.
“This rule would put American pension beneficiaries at a significant disadvantage,” Minnow and Monk wrote.
Sustainable investments are growing, and outperforming, in a volatile market
Mainstream organizations including the American Bankers Association, the Defined Contribution Institutional Investment Association, Investment Advisers Association, Spark Institute and others have urged the agency not to rush through an ill-considered rule. ESG principles are consistent with a manager’s fiduciary responsibility, BlackRock’s Larry Fink told Barron’s.
“The proposed rule from DOL is the latest example of a short-sighted and ideological crusade to stifle the growth of ESG investment market,” the U.S. Impact Investing Alliance argues in its own draft comment on the rule. The hundreds of comments may not stop the rule from advancing, but could bolster future challenges in Congress and the courts, the Alliance said.
“The DOL must consider every comment they receive, so by citing the existing literature, we obligate the department to review and respond to the data which we believe supports the case for the materiality of ESG factors.”
Of course, not every investor is opposed to the rule. In a spirited defense of “fiduciary duty,” Charles River Development’s Randy Bullard wrote, “The near universal advocacy of ESG investing puts that high ideal in jeopardy, particularly in the context of fiduciary pension boards.”
The proposed rule appears to be a response to President Trump’s executive order last year directing the Department of Labor to examine pension plan practices with an eye toward stemming their exit from fossil fuel investments.
“There is no rhyme or reason or rationale except to try to appease a president that asked them to do everything they could to encourage coal and fossil fuel consumption,” says Lukomnik. Some investors have pointed out that the DOL rule could in fact require fund managers to choose funds that exclude fossil fuels, which in many cases have outperformed those that include them.
“The rule should be turned upside down,” Lukomnik argues in his letter. “Plan fiduciaries should be required to consider all factors which affect risk and return, or justify why they do not.”
Morningstar data shows that in 2019, 35% of sustainable funds placed in the top quartile of their respective categories, and nearly two-thirds finished in the top two quartiles. In the first quarter of 2020, 44% ranked in the top quartile.
The administration’s efforts “have nothing to do with helping investors make better decisions or with helping working people achieve better returns for their retirements,” writes Morningstar’s John Hale. “They have everything to do with the Administration’s desire to preserve an economic system that has promoted inequality, racism, and climate destruction.”
Hale said proponents of the rules are not neutral arbiters. “They are political ideologues who see this in political terms and are using concepts like fiduciary duty to try to keep investors from quite reasonably and responsibly considering material issues like climate risk in investment analysis.
“This is why we have elections,” he added.
Focus on workers, customers and governance drive ESG outperformance amid COVID uncertainty
Along with the proposed Department of Labor rule, the administration has pressed the Securities and Exchange Commission to limit the use of shareholder resolutions, which investors have used for years to push corporations for better disclosure on ESG-related issues.
On Wednesday, the Securities and Exchange Commission voted 3-1 to clip the wings of proxy advisory services. The firms, which advise investors on how to vote on elections and environmental, social and governance issues before companies, have often sided with shareholder activists. A related proposal would make it harder for shareholders to file resolutions, which hold corporate management accountable. A final vote on that rule is expected in the fall.
The spirited response from the investor community may represent a repressed urge to push back more broadly against an administration that is rolling back environmental protections, cracking down on social protests, and shredding governance norms. The Trump administration has tried to make opposition to the common-sense application of ESG approaches and all they touch on – climate risk, respect for workers, board diversity – into a political loyalty test, much like refusing to wear a mask to reduce the spread of the coronavirus.
“There’s an emerging economy based on justice and sustainability,” As You Sow’s Andy Behar told ImpactAlpha. “Companies are making the decision that they want to be a part of that and they don’t want to be part of the extractive economy. That’s what they are frightened by.”