Restrictions Loosened in Employer Sponsored Plans for Environmental, Social and Corporate Governance (ESG) Investment Options

Mar 7, 2023 | 2023, Retirement Plan Law

On November 22, 2022, the U.S. Department of Labor (DOL) issued a final rule, Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, that will make it easier for Plan Sponsors to consider ESG or “Environmental, Social and Corporate Governance” factors when selecting investment options for their employer-sponsored plans.

 

Give Your Employees What They Want

The new rule brings a new provision clarifying that fiduciaries do not violate their duty of loyalty when taking participants preference into consideration when constructing the investment menu to include ESG oriented funds for participant-directed plans.

  • 75% of plan participants said they would or might increase their contribution rate if their plan offered ESG options.[1]
  • The new rule could positively affect participant behaviors leading to increased contribution rates in investment strategies that align with their core values.
  • Younger workers may be more likely to invest in their company retirement plan if they have access to ESG related funds.

Other modifications include:

  • A broader description around the factors that a fiduciary determines are relevant to a risk-return analysis (e.g., economic effects of climate change).
  • The final rule amends the current regulation’s “tiebreaker” test. Instead, a fiduciary must conclude prudently that competing investments equally serve the financial interest of the plan over the appropriate time horizon.
  • Removal of two “safe harbors” for proxy voting policies that allowed plan sponsors to limit voting resources if they deemed the issue to be immaterial or below a quantitative threshold.

 

Significant Growth in ESG Investing

ESG investing not only looks at an investment’s performance but its overall impact in three specific categoriesenvironmental, social, and corporate governance. Socially conscious investors have been driving the growing ESG demand. A recent survey showed that over 80% of Gen Z and almost 66% of Millennial investors invest in ESG-oriented investments. Both generations account for roughly 43% and 49% of the U.S. population.[1]

ESG investing has gained significant traction in recent years. According to a recent report, ESG related assets under management (AUM) are expected to increase to $33.9 trillion in 2026 from $18.4 trillion in 2021. These assets are on pace to represent 21.5% of total global AUM in less than 5 years.[2]

 

Duty of Prudence and Loyalty Still Applies

This rule can help plan sponsors create plans that adapt to the growing demand of ESG investing while helping participants get the most out of their retirement savings. The final rule became effective on January 30, 2023.

[1] Schroders US Retirement Survey 2022

[2] Nasdaq, How Millennials and Gen Z Are Driving Growth Behind ESG, September 2022

[3] PwC, Asset and wealth management revolution 2022: Exponential expectations for ESG

How To Benefit Retroactive from A Cash Balance Plans | A Tax-Friendly Solution.

Potential Enhancements Coming Soon to the Voluntary Fiduciary Correction Program.

Upcoming Compliance Deadlines for Defined Contribution Plans.

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