The Biden administration just made ESG investment easier, but the strategy remains controversial as ever


By Wilfred Chan

After a yearlong wait, the Biden administration has issued a new rule that could make it easier for your retirement plan to invest in environmentally responsible funds. 

The Department of Labor rule announced today that plan sponsors of private pensions and other benefit plans covered under the Employee Retirement Income Security Act (ERISA) may now take into account ESG factors—that stands for “environmental, social, governance”—in deciding how to maximize your investments’ returns. The new guidance reverses a Trump-era directive that effectively prevented pension firms from citing ESG factors in justifying their decisions. 

“Today’s rule clarifies that retirement plan fiduciaries can take into account the potential financial benefits of investing in companies committed to positive environmental, social and governance actions as they help plan participants make the most of their retirement benefits,” said Secretary of Labor Marty Walsh in a press release. 

The DOL announcement follows a Monday letter to congressional leaders by 17 Democratic attorneys general defending the use of ESG strategies in investing. That letter was a response to their Republican AG counterparts, who over the past year have been threatening lawsuits against federal agencies and private investment firms that have adopted ESG policies or strategies. Many Republican states have also passed anti-ESG laws in that time span. 

But why is ESG so controversial, and what are the arguments on each side?

The Biden administration just made ESG investment easier, but the strategy remains controversial as ever

Todd Cort, a senior lecturer at the Yale School of Management who researches corporate sustainability, says the concept of ESG “came onto the scene between five and 10 years ago,” growing initially in Europe before gaining traction in the United States. The term is, as Cort puts it, a “really big umbrella,” from coldly rational calculations of climate disruptions to morally driven business ventures. And that broad definition is “the crux of the problem,” he says. 

In business, corporate directors and trustees contracted to manage investment portfolios are bound by fiduciary duty, which generally means “maximizing return over the shortest period of time possible,” Cort says. For employer-provided retirement funds, that’s defined by ERISA, a federal law that requires funds “to run the plan solely in the interest of participants and beneficiaries.” 

That’s where the disagreement over ESG begins. “At the heart of the backlash is that we’re using one term to refer to two very different investor strategies,” says Cort. The first is a fiduciary investor strategy, in which an investor uses ESG information in order to maximize returns. The second is a concessionary investment strategy, in which an investor sacrifices some financial return in exchange for a social benefit. “The political right is latching onto concessionary capital, and saying, ‘No, we can’t do that, it’s not fiduciary duty,’” Cort says. Many on the left, on the other hand, often complain that “‘ESG is just another term for making more money, and that’s not going to save the world,’” he continues. “So we just have too broad of a definition.” Another problem is that many investments labeled as ESG don’t report their data using common standards, so it’s hard for investors to compare them against each other, increasing the confusion, Cort adds. 

According to Jacob Eigner, a 401(k) attorney at the Groom Law Group and a former ESG mutual fund salesman, “ESG is in the eye of the beholder.” ESG opponents may argue that the looseness of the term makes it an unreasonably risky investment strategy, while proponents might say ESG should be treated as basic economic concerns because climate change is all-encompassing, he says. It’s also plausible to imagine that an ESG strategy could pick investments that perform well as environmental problems worsen. “They could highlight the size of the marketplace and say it’s too big of a pool of money to force to the sidelines, given the issues the world is facing.” 

That seems to be the approach taken by the Department of Labor, which says its new rule “retains the core principle” that fiduciaries must focus on “relevant risk-return factors and not subordinate the interests of participants and beneficiaries… to objects unrelated to the provision of benefits under the plan.” In other words, ESG factors can be considered—as long as they’re treated as financially relevant information.

It’s the same logic given by the Democratic attorneys general, who have emphasized in their letter that ESG is about “value, not values.” “Consideration of ESG factors alongside all other material factors does not ‘sacrifice’ pensioner retirements to further a political agenda; it simply acknowledges that environmental, social, and governance issues are material factors that can affect returns,” it says. For example, per the letter, “climate change poses significant risks to many corporations in the form of physical impacts like sea level rise, extreme drought, more powerful hurricanes, and longer-lasting and more intense wildfires”—and weighing those factors is simply “part of prudent investment decision-making.” Instead, the letter continues, it’s the Republicans who “appear to favor partisan politics and fidelity to the fossil fuel industry over the essential tenets that have long governed our capital markets. And by doing so they risk their residents’ financial well-being.”

The debate may not be over soon: It’s become a “very long tennis match of hitting the ball back and forth,” Eigner says, leaving fund managers nervous. Regardless of Biden’s new rule, Republicans are likely to counter at the state level, so “we expect uncertainty in this space for plan sponsors to continue.” Without more clarity around ESG, investors may be reluctant to shift their capital toward increasingly urgent environmental needs—even if there’s a long-term financial incentive to do so.

Fast Company