President Biden used the first veto of his term on a niche investment topic that has captured national attention, ESG investing. ESG is an acronym for the use of environmental, social and governance considerations in investing.
ESG is important when seeking to connect with women as clients because women are more likely than men to be interested in ESG impacts through their financial portfolios. The topic has become politicized because it may affect the allocation of investments across various sources of energy, such as coal, renewables, oil, or gas. Such shifts could create winners and losers among energy companies, and the states where they do business. Moreover, the Biden veto protects a Department of Labor (DOL) amendment to the ERISA fiduciary duty rules, which regulate financial professionals advising on pension plans, 401(k)s and other retirement and endowment funds.
Implications Of The Biden Veto
The DOL under Biden released its final amendment to the ERISA rule on November 22, 2022, just before the Republicans won control of the House. The Republican-led Congress, however, opposes the Biden administration’s approach to ESG and voted to kill the rule by using a mechanism called the Congressional Review Act, which enables Congress to overturn actions taken during the end of a prior Congressional term.
Biden’s veto secured the 2022 DOL rule, which became effective on January 30 of this year. Whereas the Trump administration had a restrictive view of the type of data a fiduciary could consider, the current rule enables fiduciaries to consider ESG factors so long as they are relevant to the financial analysis.
In practice, the taxonomy of ESG remains a challenge because investors engage with such factors in numerous ways. Some use ESG integration, incorporating them into analysis for financial risk and returns. Others provide an ESG screen to remove securities based on values such as fossil fuels, guns, or other ethical considerations. Thematic investing focuses on specific factors, such as women on corporate boards. Additionally, impact investing measures the social and financial outcomes that the fund or business activity has on society.
Collateral Benefits
Not all of ESG relates to ethics or social benefit (as I’ve written about here). The DOL distinguishes between “risk and return analysis” and “collateral benefit” approaches. A risk and return analysis would consider, for instance, how climate change will impact the physical infrastructure of a corporation’s factories in flood-prone areas. Collateral benefits, however, consider the benefit of reduced greenhouse gas emissions to “third parties”—that is, those who are not necessarily the investor or shareholder to whom the fiduciary owes a duty.
The collateral benefits approach is the crux of the ESG debates. Biden’s final rule clarifies that ERISA fiduciaries can use factors that reasonably relate to the risk and return analysis of an investment. When it comes to collateral benefits, however, they can only be considered when needed to break a tie between two possible investment opportunities.
Biden’s tie-breaker approach is similar to the Trump-era rule, but it provides more flexibility to fiduciaries, allowing them to choose an investment with collateral benefits so long as it “equally serves the financial interests of the plan.” The Trump-era rule only permitted collateral benefit investments when they were “economically indistinguishable,” a higher bar.
ESG will likely remain on the political agenda, although Biden’s veto preserves flexibility for financial professionals, for now. Ideally, by creating opportunities for financial professionals to engage with ESG factors, it can also enable evolution towards ESG 2.0.
Azish Filabi, J.D., M.A., is Charles Lamont Post Chair and Associate Professor of Business Ethics at The American College of Financial Services and Executive Director of The American College of Financial Services Maguire Center for Ethics.