Biden administration loosens Trump-era ESG rules for 401(k) plans

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The Biden administration issued a final rule on Tuesday that makes it easier for employers to consider climate change and other so-called environmental, social and governance factors when choosing investment funds for their 401(k) plans.

The U.S. Department of Labor rule, which takes effect in 60 days, undoes regulations put in place during the Trump administration.

Those previous rules, issued in 2020, had a “chilling” effect that effectively prevented employers from weighing ESG factors when choosing 401(k) funds, senior Labor Department officials said said during a press call on Tuesday.

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ESG investing is also known as sustainable or impact investing. There are many flavors of ESG funds; for example, they can direct investor money to wind and solar companies, companies with diverse board members or away from companies involved in fossil fuels.

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ESG funds have become more popular in recent years. Investors poured $69.2 billion into them in 2021, an annual record, according to Morningstar. However, uptake in 401(k) plans has been slow.

The Inflation Reduction Act is expected to boost overall popularity. The law, which President Joe Biden signed into law in August, represents the largest federal investment to fight climate change in American history.

What the new Biden ESG rules do

Employers have a legal duty to thoroughly evaluate funds’ risk and return when choosing 401(k) plan investments; they cannot subordinate the financial interests of workers in favor of a cause such as, for example, climate change.

The new ESG rules do not change these duties.

However, they explain that businesses can include “the economic effects of climate change and other ESG considerations” when making investment choices — something that Lisa Gomez, assistant secretary of labor for the Employee Benefits Security Administration, called “common sense.”

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“While climate change is a critical issue, it is not [just] that’s what this rule is about,” Gomez said.

ESG has

Employers also do not violate their legal duty to consider workers’ ESG interests when putting together a series of 401(k) investment funds, according to the new rule; this could lead to more engagement among workers and therefore more retirement security, it said.

The action by the Biden administration on Tuesday follows a directive from March 2021 that it would not enforce the Trump-era rules. The administration then proposed a review of those rules in October 2021; Tuesday’s action updates that proposal according to comments received from the public.

The new Biden regulations scrap certain elements of the Trump-era rules that Labor Department officials said prevented employers from using ESG funds.

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For example, the previous rules did not explicitly mention ESG; but they required employers to choose investments based only on “monetary” factors — a term that essentially prohibited employers from choosing funds with any kind of “moral” component, Labor Department officials said.

The new Biden administration rules wipe out that requirement.

“Whether E, S, or G, … direct or indirect, great or small, the [ESG] factor also fosters a moral component,” said a senior Department of Labor official, who spoke only on condition of background. “ESG has an inherent duality of purpose.”

The new rules also delete a restriction that prohibited employers from using an ESG fund as a default option for workers automatically enrolled in their 401(k) plans — an increasingly popular way to boost retirement security. In legal parlance, these funds are known as a “qualified defined investment alternative,” or QDIA.

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