Investment strategies that consider environmental, social and governance factors may soon find their way into employer-sponsored retirement plans, expanding access to millions of Americans whose only stake in the market is through a 401(k) or similar account.

Senate Democrats this month introduced legislation that would amend a 1974 law known as the Employee Retirement Income Security Act to allow fiduciaries to consider ESG factors in selecting investment strategies for employer-sponsored plans and reverse a rule by the Trump administration that limited their ability to recommend such products.

President Joe Biden issued an executive order that directed federal agencies to consider financial risks tied to climate change and specifically asked the Labor Department to consider rescinding the previous administration’s rule while taking steps to protect worker pensions and retirement savings.

ESG has become one of the hottest trends in capital markets as investors increasingly consider nonfinancial factors when weighing risk and growth opportunities. In this era of stakeholder capitalism, corporate policies aimed at reducing greenhouse gas emissions and increasing diversity in upper management are valued along with investment returns.

The overall value of assets under management at funds focused on ESG last year surged to more than $40 trillion, almost twice the size of the U.S. economy, from $22.9 trillion in 2016, according to Opimas LLC, a management consultancy focused on global capital markets.

With ESG investing surging, some observers say they hope that the recent moves by the White House and congressional Democrats can draw bipartisan support to align regulations with modern investors’ retirement goals.

“Retirement plan sponsors and participants deserve the freedom to choose the 401(k) investment that best suits their needs,” Brian Graff, CEO of the American Retirement Association, said in a statement in support of proposed legislation.

The ARA supports any legislative or regulatory change that allows ESG investments to be considered by plan sponsors or participants just like any other investments, Graff told CQ Roll Call in an interview.

“This is market-driven,” Graff said. Most Americans invest only through their 401(k)s, so they haven’t been able to tap into ESG investment strategies due to “artificial barriers” within the regulations, he said.

The Senate bill was introduced May 20 by Tina Smith, D-Minn., Richard Blumenthal, D-Conn., and Patty Murray, D-Wash. A companion bill was introduced the same day in the House by Rep. Suzan DelBene, D-Wash.

Rep. Andy Levin, D-Mich., plans to introduce two bills Thursday aimed at promoting transparency in ESG investing, a spokesperson for the lawmaker told CQ Roll Call.

One of Levin’s proposals would require investment advisers to file a written Sustainable Investment Policy disclosing certain factors considered in making investment decisions, such as environmental harm, human rights, and diversity and inclusion practices, according to the spokesperson. Levin’s other bill would encourage but not require ERISA plans to adopt SIPs.

Levin’s proposals would affirm that ERISA-regulated plans may invest plan assets in sustainable investments so long as it is in the plan beneficiary’s best financial interest, and ESG products would be allowed to serve as qualified default investment alternatives.

No Republicans have endorsed any policy changes so far.

North Carolina Sen. Richard M. Burr, the ranking Republican on the Health, Education, Labor and Pensions Committee, which has jurisdiction over the proposal, didn’t immediately respond to a request for comment. Other Republicans voiced opposition to Biden’s attempt to change the policy, at least via executive order.

The executive order “demonstrates that the Biden administration is preparing to misuse financial regulation to further environmental policy objectives,” Sen. Patrick J. Toomey, R-Penn., said in a statement. “Not only would such regulation exceed the scope of financial regulators’ respective missions and authorities, but it would also distort capital allocation, raise energy costs for consumers, and slow economic growth.”

The pendulum swings

The proposed legislation and Biden’s executive order aim to clarify policies after President Donald Trump’s Labor Department issued a final rule in November that limited the use of ESG factors under ERISA’s fiduciary standards.

A central provision in that final rule stated that ESG considerations couldn’t be included in qualified default investment alternatives. QDIAs are default plans for employees who fail to make any selection among various plans offered, which includes millions of retirement investors.

Bryan McGannon, a spokesperson for US SIF: The Forum for Sustainable and Responsible Investment, told CQ Roll Call that partisan swings from one administration to the next on this topic create too much uncertainty for ESG strategies to be considered for most retirement plans.

The Labor Department issued guidance in 2015 under President Barack Obama that authorized fiduciaries to take ESG factors into account as “tiebreakers” between investments otherwise deemed equivalent. McGannon called that move “a step in the right direction.”

However, the Trump administration swung the pendulum in the opposite direction, he said, when it put out its rules to limit ESG considerations and refocused fiduciaries on maximizing economic returns. 

Under that rule, retirement plan fiduciaries couldn’t consider any non-money factors if an investment decision could be made on money factors alone. The rule’s preamble also said the Labor Department found it inconsistent with ERISA for a fiduciary to consider any factors that present economic risks but aren’t based on “generally accepted investment theories.”

While there was likely some wiggle room in the 2020 rule, many risk-averse fiduciaries preferred to simply avoid the confusion, which left many retirement investors out of the ESG sector entirely, McGannon said.

Last year’s rule-making period attracted more than 8,000 public comments, and more than 95 percent were critical of the changes, according to McGannon, who hopes the overwhelming opposition will facilitate bipartisanship to allow millions of retirement investors to consider ESG products.

“We’ve never seen this kind of alignment,” McGannon said. “The market has moved. By and large, the market says ESG is important to investment decision-making.”

Trillions in wealth

ERISA governs a broad range of private employers’ retirement and health benefit plans. It covers defined benefit plans, such as pensions, as well as defined contribution plans, such as 401(k)s for private sector employees, 403(b)s for public educators and employees of nonprofits and government entities, and many other variations.

ERISA plans contain more than $10 trillion in assets and cover more than 150 million American workers and their dependents, according to Labor Department data. Although more than half of Americans are invested in capital markets, less than 15 percent directly own stock, according to the Pew Research Center. Most stock market holdings are indirect, through retirement accounts.

Studies conducted by New York University, Morgan Stanley and others have also shown that investments based on ESG-related strategies can outperform conventional ones. Industry experts, including Graff and McGannon, say they want retirement investors to have a level playing field.

Republicans who have previously opposed ESG considerations as a distraction from maximizing financial returns could now feel pressure from millions of retirement investors, large asset managers such as BlackRock Inc. and other industry groups that support policies to allow retirement plan fiduciaries to incorporate ESG investment strategies.

“The level of support from industry and investors bodes well for bipartisanship,” McGannon said.