There's More to the ESG Investing Fight than Meets the Eye

There is more political significance to the Republican resolution to amend retirement-plan rules than it is to the retirement plan itself. The bill still needs to be vetoed by Biden.

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There has been yet another volley fired by congressional Republicans in the ongoing war against environmental and socially conscious investing in the United States. President Joe Biden is right to veto the bill even though their attempt to influence retirement-plan managers is more political than consequential.

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Private-sector retirement plans hold some $12 trillion in assets, and the issue at issue is whether they should be allowed to explicitly consider environmental, social, and governance issues when selecting investments in their plans. Trump administration officials recently adopted a new rule in late 2020, intended to discourage such behavior. According to it, fiduciaries — those who, for example, oversee company pension funds or 401(k) plans — would have a greater burden to prove that the consideration of environmental, social, and governance issues was solely "pecuniary," potentially putting them at greater risk of litigation. For example, to demonstrate that an ESG choice was economically indistinguishable from a non-ESG alternative, certain ESG choices required extra documentation demonstrating that the choice was economically unattractive.

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Due to the rapid announcement of a reversal by the Biden administration, it is hard to know what effect the rule would have had. In the revised version released late last year, the addition of documentation has been eliminated and factors such as the "economic effects of climate change" have been identified as potentially relevant to the investment analysis process. Fiduciaries today have a greater opportunity to explicitly consider ESG issues as well as offer ESG funds for their clients, but they are not required to do so through this shift in their emphasis. While the rule still requires them to act in the financial interest of plan participants, it still requires them to do so. 

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One of the most important aspects of the Trump and Biden rules is where they agree: Properly diversified investments should be one of the primary goals of a fiduciary, to enable future retirees to take advantage of the most advantageous combination of risk and return. Cryptocurrencies should be excluded from this list. However, it is not in any way incompatible with the concept of ESG investing. For instance, if the profits of a company are too heavily dependent on activities that are contributing to climate change, any asset manager would reasonably see this as a potential threat to the value of that enterprise. There's no difference between investing and investing, regardless of the label you give it. Fiduciaries of plans are under no circumstances allowed to accept greater risks or less returns under any circumstances as a means of pursuing ESG goals (although this is a strategy that is used by a number of broader investment organizations). Furthermore, they should ensure that ESG-labeled funds are what they claim to be - something that has often not been the case in the past.

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However, the Republican Party often seems more interested in attacking ESG as a form of "woke capitalism", rather than actually focusing on the finer points of portfolio selection. To this end, they've been able to secure the necessary votes in both the House and Senate to pass a resolution that will overturn the Biden rule as a result of these votes. Considering the similarities between the two rules, this is a much bigger deal for the culture wars than it would be for the financial sector. Even so, there's a chance that the resolution may create enough uncertainty to chill otherwise useful investments if it is allowed to stand.

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In keeping with his pledge, Biden should use his veto.