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Sustainable investment groups weigh next steps on Labor Department's ESG rule

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Sustainable investment groups weigh next steps on Labor Department's ESG rule

A controversial rule recently adopted by the U.S. Department of Labor has incited a wave of backlash from the sustainable investing community.

Under the finalized proposal from the Labor Department, fiduciaries working on retirement plans that fall within the scope of the Employee Retirement Income Security Act of 1974, or ERISA, must now consider investments based purely on financial risks and returns, marking a blow to the prospect for environmental, social and governance investments to gain share in the retirement plan market. The rule's passage came despite thousands of comment letters from investors, U.S. senators and others that heavily criticized the proposal.

"It continues to be striking that they did this in the face of overwhelming opposition from investors," Jonas Kron, chief advocacy officer at Trillium Asset Management LLC and a board member of U.S. SIF: The Forum for Sustainable and Responsible Investment, said in an interview. "[U.S. Labor Secretary Eugene Scalia] jumped in, stuck his arm out and said stop. He's trying to stop what people are demanding."

While ESG investing in some form dates back decades, the practice has seen exponential buy-in over the last five years from what proponents say is investors waking up to the benefits of viewing their portfolios with an eye on the risks and opportunities in a company's environment footprint, corporate governance structure or supply chain. The mounting interest has led to sweeping changes once unthinkable across Wall Street and corporate America. Big banks have worked to cut their lending portfolios' exposures to fossil fuels. Energy giants have transformed their businesses to ramp up renewable energies. And the world's largest asset managers, including BlackRock Inc. and State Street Global Advisors Inc., have threatened to pull some of their money out of certain companies' stocks if they do not start thinking about ESG risks.

The DOL acknowledged in the final rule that certain ESG issues like climate change and poor corporate governance can create "an economic business risk or opportunity" to companies and their investors. However, like many ESG skeptics, the DOL raised concerns about whether an ERISA plan fiduciary could be swayed by the rising momentum behind ESG to pick investments that carry higher fees with worse returns, ultimately hurting beneficiaries. While the agency did not flatly ban fiduciaries from selecting ESG funds, advisers will face a higher hurdle based on an ESG product's financial performance and risks to justify picking it over a traditional fund.

But that justification could be easy to make in some cases, as many ESG-focused funds outperformed standard indices over the past year.

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"Protecting retirement savings is a core mission of the U.S. Department of Labor and a chief public policy goal for our nation," Scalia said in a statement. "This rule will ensure that retirement plan fiduciaries are focused on the financial interests of plan participants and beneficiaries rather than on other, non-pecuniary goals or policy objectives."

The rule's fate is already in question, though.

Whether the rule goes into effect could be dependent on the U.S. elections Nov. 3, experts said. If a blue wave were to occur, where former Vice President Joe Biden wins the White House and Democrats take the U.S. Senate, lawmakers could unravel the DOL rule under the Congressional Review Act, which allows lawmakers and the president to repeal a federal agency's rule as long as they vote to do so within 60 legislative days, Ropes & Gray Partner Josh Lichtenstein said in an interview.

The process that the DOL used to get the rule over the finish line has also raised questions about whether the agency followed the appropriate protocols under the Administrative Procedure Act, which could lead to a lawsuit that would tie up the rule, Lichtenstein said.

U.S. SIF, a preeminent sustainable investing advocacy group, has been weighing its options for how to further challenge the DOL's rule, according to Bryan McGannon, its director of policy and programs. The group's favored option at this point is to convince Congress to amend ERISA to put a stop to the "pendulum" of administrations interpreting the law's language differently about sustainable investing every few years and then subsequently issuing their own guidance on it, McGannon said. And while doing so would be easier if the Democrats take the Senate, McGannon said there would still be a chance of it with a Republican-controlled Senate considering the tremendous buy-in from the financial community around ESG.

"For 30 years, it's just been guidance documents that have dictated" how fiduciaries should be thinking about sustainable investing, McGannon said in an interview. "Given the mounting opposition, we might have an opportunity to put it in the statute to clearly state they may consider these factors."

READ MORE: Sign up for our weekly ESG newsletter here, read our latest coverage of environmental, social and governance issues here and listen to the ESG Insider podcast on Spotify or Apple Podcasts.