Capitol Hill and Regulators to Remain Focused on ESG in the 117th Congress
- Ben Parish, Vice President, Government Relations, SFA
- Kelly McGrath, Associate Vice President Government Relations, Porterfield, Fettig & Sears, LLC
The Environmental, Social, and Governance (ESG) investing movement is maturing in the United States and institutions and investors are increasingly focusing on ensuring their actions and decisions support shaping the future for the better. On Capitol Hill, regulators and elected officials are also working to establish tools to help facilitate the ESG movement particularly with respect to ESG labelling and transparency obligations, which in turn, could help investors integrate and utilize ESG data.
Congress (House Financial Services and Senate Banking Committees)
Upon becoming Chairwoman of the House Financial Services Committee (HFSC) two years ago, Maxine Waters (D-CA), the first African American and woman to chair the committee, has prioritized building on past social justice efforts and confronting the lack of diversity and inclusion in U.S. financial institutions. Through the newly established Diversity and Inclusion Subcommittee, Chair Waters requested information on diversity and inclusion data policies from 44 of the nation’s largest banks. Additionally, on July 11, 2019, the HFSC passed three bills with sizeable bipartisan majorities that address the governance shortcomings in America’s financial services industry. The Chairwoman’s agenda, and market demands, have also led some financial institutions to increase their focus and resources on Social and Governance factors.
The federal government’s response to the COVID-19 pandemic and protests calling for a more just and equitable society amplified the ESG message and elected officials have asked financial regulators to play a role in reducing barriers to equal access to affordable products and services within the financial system. On September 20, Senator Elizabeth Warren (D-MA) called on Federal Reserve Chairman Jerome Powell to use the Fed’s tools to help address and eliminate such disparities. Senator Warren has also introduced the Federal Reserve Racial and Economic Equity Act to ensure racial and economic inequalities are not ignored by making part of the Fed’s mission reducing these disparities and requiring robust reporting on the labor force. “The Fed can use its existing authorities to reverse the serious racial gaps in our economy, including in our current recovery from the COVID-19 crisis – and our bill will require the Fed to do so,” said Senator Warren. “Systemic racism and inequality is not something that happens on its own. It is a result of specific policy choices and the Fed must take deliberate action to fix it.” Senate Banking Committee co-sponsors include Ranking Member Sherrod Brown (D-OH), Jack Reed (D-RI), Chris Van Hollen (D-MD), and Catherine Cortez Masto (D-NV). And this past October, Atlanta Fed Chairman Rafael Bostic called for a new focus on race and the economy. Bostic’s address is especially noteworthy given the rumblings that he could be a short list candidate for either Treasury Secretary or Federal Reserve Chairman in the Biden administration.
While none of the bills noted above are expected to become law this Congress, they do provide a benchmark measure for future bipartisan negotiations on ESG legislation.
Securities Exchange Commission (Asset Management Advisory Committee, ESG Subcommittee)
The Securities Exchange Commission’s (SEC), Asset Management Advisory Committee (AMAC) was updated by its ESG Subcommittee on five workstreams they have been examining: Value vs. Values, Performance Measurement, Proxy Voting, the role of ESG Rating Systems and Benchmarks, and Issuer Disclosure. Some of the major points centered around whether the Names Rule should apply to ESG strategies, what disclosures should be required for ESG investing, how are value and return calculated and presented to investors, how has COVID impacted ESG investing, should E, S and G factors be further delineated instead of paired, the impact of proxy voting, and overall steps the SEC can take in this space.
The subcommittee’s report also described how these workstreams fit together to help facilitate a spectrum of potential actions for performance management, ESG rating systems, and issuer disclosure. Importantly, the range of potential actions discussed at this meeting was intended to stimulate further discussion and solicit additional feedback from the AMAC. The ESG Subcommittee is expected to submit final recommendations at the December AMAC meeting.
We expect continued engagement on ESG from the SEC, especially from Commissioners Allison Herren Lee and Caroline Crenshaw, who have prioritized the issue as evidenced in the following excerpt from an August 26, 2020 public statement by Commissioner Lee titled Regulation S-K and ESG Disclosures: An Unsustainable Silence. “There is room for discussion as to which specific ESG risks and impacts should be disclosed and how. But the time for silence has passed. It’s time for the SEC to lead a discussion—to bring all interested parties to the table and begin to work through how to get investors the standardized, consistent, reliable, and comparable ESG disclosures they need to protect their investments and allocate capital toward a sustainable economy.” Biden’s victory points to Democrats controlling the SEC, and we can certainly expect an increased focus on ESG disclosures and investing.
Read the full summary from the September 16 AMAC meeting.
Department of Labor (Employee Benefits Security Administration)
The Department of Labor (DOL) has also focused on the topic of ESG, proposing its
Financial Factors in Selecting Plan Investments regulation on June 23 and releasing the final rule on October 30. In the preamble of the proposed rule, the DOL described an “upward trend” in using the term ESG among institutional asset managers and raised concerns about the lack of precision and rigor in the ESG investment marketplace. DOL noted ESG investing “raises heightened concerns under ERISA” and that “growing emphasis on ESG investing may be prompting ERISA plan fiduciaries to make investment decisions for purposes distinct from providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan.”
The Department’s final rule adopts the proposal’s general restatement of the loyalty duty under ERISA section 404(a)(1)(A) and addressed comments received by continuing to treat the original 1979 regulation’s provisions on the fiduciary duty of prudence as a safe harbor. It also sets out a new provision regarding a fiduciary’s duty of loyalty under ERISA section 404(a)(1)(A) as minimum requirements for meeting the statutory standard of loyalty. Additionally, the rule:
- Concluded that the lack of a precise or generally accepted definition of “ESG,” either collectively or separately as “E, S, and G,” made ESG terminology not appropriate as a regulatory standard. Therefore, the rule does not explicitly define ESG or ESG funds and instead refers to “pecuniary factors” and “non-pecuniary factors” – financial considerations that have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and funding policy.
- Includes provisions to confirm that ERISA fiduciaries evaluate reasonably available alternatives and investment courses of action based solely on economic factors.
- Permits the selection of funds seeking to promote one or more non-monetary objectives if the selection satisfies the prudence and loyalty principles of ERISA.
- Includes new regulatory text that sets forth required investment analysis and documentation requirements for limited circumstances in which plan fiduciaries may use non-economic factors to choose between or among investments that the fiduciary cannot distinguish based on pecuniary factors alone.
- Modifies the provision in the proposal on qualified default investment alternatives (QDIAs), and prohibits plans from adding or retaining any investment fund, product, or model portfolio as a QDIA, or as a component of such a default investment alternative, if its objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more non-pecuniary factors.
Notably, instead of continuing its previous pattern of issuing sub-regulatory guidance and despite pushback from the industry, the DOL rule codifies in regulation its interpretation of ERISA’s fiduciary duties as applied to the consideration of ESG factors concerning plan investments. The rule will be effective 60 days after publication in the Federal Register, but plans will have until April 30, 2022, to make any changes to certain qualified default investment alternatives, where necessary to comply with the final rule. However, our expectation is the Biden Administration will likely suspend the rule as it is rewritten or use the Congressional Review Act to nullify the rule.
A news release from DOL on the final rule is available here.
A DOL fact sheet on the final rule is available here.
SFA will be hosting its 2nd Annual ESG Symposium December 15-16, and continue monitoring ESG-related developments in Congress, SEC, and DOL and provide timely updates as these issues continue to develop.
Sign up for our ESG Task Force to participate in the ESG workstreams and stay up to date on SFA’s coverage of ESG within our market.