Balancing Fiduciary Duty With ESG Demand

As desire for sustainable investments increases, retirement plan sponsors are still cautious about offering ESG funds while regulatory guidance is stalled.

Interest in environmental, social and governance (ESG) investing continues to increase, but how can defined contribution (DC) plan sponsors meet participants’ and their own interests while still abiding by their fiduciary duties under the Employee Retirement Income Security Act (ERISA)?

That balance is so important that the Department of Labor (DOL) issued a strict proposal last year, ordering plan fiduciaries to avoid investing in ESG funds that may offer a lower return or increased risk compared to other, non-ESG funds. The proposal later was the target of intense scrutiny, with many arguing that ESG considerations are financial considerations. In response, the DOL issued a much softer stance as its final rule.

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In the public comments about the DOL’s proposed rule, Voya reported that its research found 76% of individuals surveyed felt it was important for their employer to apply ESG principles to workplace benefits, with more than half (60%) noting that they would likely contribute more to an ESG-aligned retirement plan if it was reviewed and certified as socially and environmentally responsible.

“ESG funds provide diversity and low costs, plus many investors want them,” says Patrick Dinan, a Certified Financial Planner (CFP) at Impact Fiduciary. “Some investors may be more inclined to participate in a plan if it aligns with their personal values.”

Yet, other studies show there is only slight uptake of ESG investments. A 2019 study by Cerulli Associates found that while 56% of plan sponsor respondents are interested in offering ESG funds to investors, when asked to identify the top three most important attributes they considered when selecting plan investments, “environmental and social responsibility” ranked last, chosen by only 16% of respondents.

“There is still a significant amount of uncertainty,” notes George Sepsakos, principal at Groom Law Group. “This has put plan sponsors and fiduciaries in a bit of a tricky situation.”

While the Biden administration issued a non-enforcement policy on Trump-era ESG regulations, many plan sponsors remain skeptical on the matter, adds Sepsakos. “While we can assume the Biden administration is indifferentiable on ESG matters, we still don’t know much,” he says. 

At the moment, Sepsakos sees most plan sponsors that are interested in offering ESG investments working with plan advisers and consultants to compare them with non-ESG funds. Other plan sponsors are reminding participants that they can invest in sustainable funds through a brokerage window.

However, Sepsakos anticipates the Biden administration will issue future guidance to ease any concerns about fiduciary liability. “They’ve signaled that what the Trump administration had issued is under review and I think it’s very clear that they will amend that,” he says.

Jodan Ledford, CEO of Smart, anticipates this journey toward ESG standardization will take a crawl, walk, run approach for plan sponsors and participants alike. Instead of automatically defaulting participants into an ESG fund, plan sponsors will likely start with offering an option on the investment lineup. “That’s a pretty safe bet from a fiduciary perspective because those [participants] have to opt into those investments, and then, over time, as the market evolves, I think you’ll get more and more of a standardization,” he says.

Charlie Nelson, vice chairman and chief growth officer at Voya, echoes that sentiment, saying that as standardization in ESG investments grow, so will adoption of sustainable features such as e-delivery tools, digital engagement, automatic features and match structures. “As more companies increasingly embrace ESG values in their business models, it seems inconsistent to not also do so within their benefit plans to support their employees, ultimately becoming more of the standard than unique,” he says.