In January, President Biden signed an executive order directing federal agencies to take actions to prevent climate change.
In response, both the Securities and Exchange Commission (SEC) and Department of Labor (DOL) have proposed regulations designed generally to encourage sponsors of employee benefit plans to take Environmental, Social, and Governance (ESG) factors into account when prudent, and to increase the effectiveness of ESG regulations. They do so by adding heft to reporting obligations surrounding greenhouse gas emissions and cracking down on the use of names that may imply ESG characteristics.
These recent developments in Washington make monitoring ESG regulations more crucial than ever. Several relevant rules are currently pending, and their basic provisions are summarized below.
SEC Names Rule
Most advisors are likely already familiar with the current SEC rules. In most cases, they require funds with names that suggest a focus on a particular type of investment, such as a specific country or geographic region, to invest 80% of their assets consistently with that proposed focus. For instance, with some exceptions and nuances, a fund named “U.S. Stock Fund” would generally have to invest 80% of its holdings in domestic equities in avoiding SEC scrutiny.
In May 2022, the SEC proposed to expand this requirement to apply “to any fund name with terms suggesting that the fund focuses in investments that have… terms such as growth or value and those indicating that the fund’s investment decisions incorporate one or more [ESG] factors.” (internal quotations omitted).
This new proposed regulation would further limit style drift in funds managed by covered entities and attempt to prevent ambiguity in the naming of funds that may use ESG screens or take ESG factors into account during their investment processes.
Of additional note to regulated entities are proposed updates to enhance disclosure and reporting requirements.
SEC Disclosure Rule
In March 2022, the SEC proposed rules requiring companies to disclose information regarding greenhouse gas emissions, indirect emissions, and in some cases, emissions from upstream and downstream activities in the value chain. If finalized as-is, this rule will likely lead to increased compliance and reporting demands on many entities and may make it easier for asset managers to metricize the total greenhouse gas emissions profile of funds.
DOL ESG for Plan Sponsors Rule
On the Department of Labor front, considerable developments have occurred. The Trump administration had previously finalized a rule signaling hostility to plan sponsors considering any ESG factor as “pecuniary” or material to an investment’s risk and return profile. The Biden administration has announced that it will not enforce this rule and has presented a new rule that would remove barriers to employee retirement plans considering ESG factors. The comment period for this proposed rule closed on December 13, 2021, and it is unclear when and if the rule will be finalized.
It is important to note that all three of these proposed rules are not yet law and that, if finalized, their final forms may be different than those proposed.
However, when combined with the aforementioned executive order, these proposed rules reflect a resolve to promote the ability of some institutional investors to consider ESG as part of their investment processes and to strengthen reporting surrounding ESG investing. It will be essential for advisors to employee benefit plans to continue monitoring these developments and to engage qualified experts to advise them on the legal implications of these potential changes to accomplish this end when necessary.
George Sepsakos is a principal at Groom Law Group, Chartered, where he represents clients on a broad range of ERISA, federal tax, and securities law matters. Jake Eigner is an associate at Groom Law Group, Chartered, who specializes in ERISA’s application to financial institutions.
