This post first appeared on the Climate Risk Disclosure Lab website. The Lab is a collaboration between the Global Financial Markets Center at Duke Law, Duke’s Nicholas Institute for Environmental Policy Solutions, and the National Whistleblower Center.
On June 23, 2020, the Department of Labor (“DOL”) issued a proposed regulation for public comment aimed at discouraging sustainable investing in retirement plans governed by the Employee Retirement Income Security Act of 1974 (“ERISA”). DOL wants to limit the ability of plan managers to consider environmental, social, and governance (“ESG”) risk factors in making investments and their ability to offer ESG funds. See U.S. Dep’t of Labor, Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 39113 (proposed June 30, 2020) (to be codified at 29 C.F.R. pt. 2550).
DOL’s charge under ERISA is to provide a secure retirement for American workers and retirees, but the proposed rule does the opposite. If adopted, the DOL’s proposal has the potential to expose individual retirement accounts and pension funds to hidden financial risks from climate-related impacts. Moreover, it could provide a green light to companies with weak ESG records to conceal these risks and justify their concealment by claiming they are not material to shareholder value. Whistleblowers will be needed to expose these financial risks and to highlight why they must be considered by plan managers to protect retirement assets.
Environmental, social and governance factors are generally defined as:
Environmental screening identifies companies focused on issues such as climate change, energy consumption, the use of natural resources, and reducing their carbon footprint.
Social screening identifies companies with strong employee engagement, good human rights track record, broad employee diversity, and fair labor practices.
Governance screening identifies companies with independent and diverse boards, fair compensation practices, and strong checks and balances.
Sustainable investing has skyrocketed over the last decade. According to Morningstar, as of December 31, 2019, there were 564 sustainable funds with $933 billion in assets under management that were incorporating some form of ESG screening. One of the main reasons for the increased usage of ESG risk factors and investment in ESG funds is that sustainable investing contributes to long-term investment returns and mitigates risk during periods of market volatility unlike investing in fossil fuels.
Climate risks are critical considerations in determining the actual risk and return of pension assets, and the disclosure of climate-related information is material to accurately assessing the valuation of companies. The value of global financial assets at risk from climate change is substantial and is estimated to be anywhere from $2.5 US trillion by the London School of Economics to $4.2 US trillion by the Economist.
A recent report by the National Whistleblower Center supports the conclusion that the systemic threat of climate change means significant disruptive consequences on asset valuations and our nation’s economic stability as well as the lives and livelihoods of tens of millions of Americans. The report calls on whistleblowers to work with regulators and prosecutors to expose illegal efforts in the fossil fuel sector to conceal these financial risks.
At a time when fires are ravaging California, extreme weather is leveling cornfields in Iowa, and hurricanes are pounding the Gulf Coast, the investing community needs greater disclosure of public companies’ climate-related risks in order to maximize risk-adjusted returns and protect American retirement plans. Many commenters on the proposed rule – ERISA fund managers, investment firms, non-profits, and Congressional leaders – agree. Despite an abbreviated 30-day comment period, the proposed rule received over 1,500 comments with half of the comments objecting to the proposed rule.
DOL contends, without evidence, that the proposed rule is needed, because ESG investments allegedly sacrifice financial returns in order to achieve social or policy goals. However, studies of financial returns of sustainable versus non-sustainable funds disprove DOL’s assumption.
BlackRock, the world’s largest investment management firm, analyzed the performance of 32 sustainable indices against their non-sustainable benchmarks dating back to 2015. BlackRock found that during notable market downturns in 2015-2016 and 2018, sustainable indices tended to outperform their non-sustainable counterparts –that is, they demonstrated a smaller decrease in value during the market downturn.
Whether the proposed rule becomes final is uncertain. With the comment period now closed, DOL has several options. DOL could issue an extension of the comment period, as many commenters requested; issue a request for information; proceed with the rule, meaning it would be effective 60 days after date of publication of final rule in the Federal Register; or even withdraw it. Another option is publishing a revised rule based on feedback from the comment period, which could generate the need for an additional comment period.
What is certain is that if the proposed rule becomes final, it will have a chilling effect on using ESG factors and offering ESG funds as a means of assessing and mitigating risk in retirement investments. However, regardless of the DOL decision, it is important to recognize that the federal securities whistleblower program under the Dodd-Frank Act will continue to be a critical tool to provide needed transparency and the disclosure of material climate risk information, especially from non-sustainable industries like fossil fuels. The role of whistleblowers in exposing hidden climate-related risks is increasingly essential given that the U.S. has not enacted a mandatory and standardized corporate climate disclosure regime.
Since the enactment of the Dodd-Frank Act in 2010, whistleblowers have played a central role in exposing securities frauds. Retirement plan managers and others must educate the public on the role that whistleblowers play in disclosing climate risk information. Ensuring that climate risks are disclosed and considered in investment decision making is critical for plan managers as they strive to meet their ERISA obligations to insure a secure retirement for all Americans.
Karen E. Torrent is Policy Counsel at the National Whistleblower Center
