The Department of Labor’s recent notice of proposed rulemaking on environmental, social, and governance (ESG) factors in pension fund investments has received a lot of responses, both in the official Federal Register docket and in the news media and blogosphere. One genre of responses that seems to be common is that the department’s rule (assuming it get finalized and published more or less in its current form) would represent some kind of major attack on—or even “death knell” for—ESG investing itself. Those criticisms are overstated.
One business law attorney recently blogged that the proposed rule and subsequent letters to investment firms requesting information about their ESG practices constituted “another nail in the coffin of environmental, social and governance (‘ESG’) disclosures” and made it “more likely that ESG will be consigned to the ash heap of history.” This dire prognosis will no doubt come as a surprise to ESG’s vocal advocates, who routinely declare it to be “an unstoppable force” with “inevitable” consequences.
To clarify, the proposed rule applies only to fund managers who serve as fiduciaries for private pension funds regulated under the Employee Retirement Income Security Act of 1974 (ERISA). It also only applies when a fund manager explicitly prioritizes the advancement of environmental and social issues over providing maximum returns to beneficiaries—a goal that ERISA has always required. As the department’s initial filing pointed out, not only is the current proposal not a departure from the existing statutory interpretation, it’s not even a meaningful departure from previous sub-regulatory guidance issued in previous administrations.
Asset managers are free to continue offering and marketing ESG-themed investment funds, and individual firms are free to continue making whatever sort of ESG disclosures they think is reasonable, whether under their own guidance or pursuant to a third-party framework like the Sustainability Accounting Standards Board or the United Nations-sponsored Principles for Responsible Investment. To the extent that a firm is less eager to make extravagant claims about its own socially responsible operations, however, that’s a good thing.
Unlike standard financial disclosures about assets and liabilities, it is still unclear what exactly constitutes meaningful ESG disclosure. As Securities and Exchange Commissioner Hester Peirce said in a 2018 speech, “While financial reporting benefits from uniform standards developed over centuries, many ESG factors rely on research that is far from settled.” This lack of specificity and uniformity has long meant that companies can claim almost anything is a positive ESG signifier without threat of refutation or litigation. If ESG claims are now considered substantive enough to be justiciable, it means they may be starting to actually mean something.
However, that will also mean that the era of the free lunch is over, and both asset managers and firm directors will need to acknowledge the financial tradeoffs required by their previously airy and aspirational ESG statements. Many ESG cheerleaders in the finance industry have long insisted that ESG investing isn’t concessionary and doesn’t have to mean accepting lower returns than those of mainstream market investing strategies. If that’s actually true, they should have no problem meeting the expectations of the Department of Labor’s new rule. This won’t be the end of ESG-themed investing, but it will likely shake up and tighten the field of true enthusiasts.