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.
Participant sentiment and trends shouldn’t drive a
fiduciary’s investment-option decisions. Still, 90% of participants say they
want options to square with their ethical values, according to “Inside the
Minds of Plan Participants,” a research report based on a proprietary AB
survey.
Some 71% of participants reported they are likely to invest
in socially responsible funds if performance and fees are comparable to other
plan investments, AB found.
“While proposed DOL
guidelines sit in the pipeline, ESG opportunities for plan sponsors are already
here. Yes, there are many different ways to access ESG investing. But a good
first step is to look carefully at plan options—from the default fund or its
underlying investments to core and stand-alone offerings—and question whether
all factors are being considered in the investment process,” the authors said.
When the bottom line is better financial outcomes, plans can
and should take an ESG integration lens across the investment line-up. For plan
sponsors, AB argued that can be achieved through ESG considerations that meet
the scope of plan rules and fiduciary responsibilities.
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