Biden administration loosens Trump-era investing rules around environment, social and governance funds for 401(k) plans

Personal finance

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The Biden administration on Tuesday issued a final rule that makes it easier for employers to consider climate change and other so-called environment, social and governance factors when picking 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 prior rules, issued in 2020, had a “chilling” effect that effectively sidelined employers from weighing ESG factors when selecting 401(k) funds, senior Labor Department officials said during a press call Tuesday.

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

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

The Inflation Reduction Act is expected to further bolster the popularity of ESG investing. The law, which President Joe Biden signed in August, represents the largest federal investment to fight climate change in U.S. history.

What the new Biden ESG rules do

Employers have a legal duty to thoroughly assess funds’ risk and return when picking 401(k) plan investments; for example, they can’t subordinate the financial interests of workers in favor of a cause like climate change.

The new ESG rules don’t change these duties.

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

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

Employers also don’t violate their legal duty by taking workers’ ESG interests into account when crafting a lineup of 401(k) investment funds, according to the new rule; that may lead to more engagement among workers and therefore more retirement security, it said.

The Biden administration’s action Tuesday follows a March 2021 directive that it wouldn’t enforce the Trump-era rules. The administration then proposed a revision to 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 stymied employers from using ESG funds.

For example, the prior rules didn’t explicitly mention ESG, and they required employers to choose investments based only on “pecuniary” factors — a term that essentially disallowed employers from selecting funds with any sort of “moral” component, Labor Department officials said.

The new Biden administration rules erase that requirement.

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

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

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