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Changes Ahead: What's New in ESG Investing?

The landscape of investing is always changing, and this is especially true when it comes to new products, concepts, and tools (SEE: cryptocurrency). With ESG (Environmental, Social, and Governance-aware) investments moving into the spotlight in recent years it was only a matter of time before regulatory changes started rolling in.

Right this moment, July of 2021, there are three topics of interest to ESG investors: the SEC’s new task-force, the DOL’s rules around ESG fund inclusion in 401(k) accounts, and tightening European regulations on ESG “greenwashing.” All of these have been in the works for years, but now they’re finally coming to implementation. Let’s talk about what this means, and what this means for you.

First, the European rules. The European Commission introduced a new rule in March of this year, called the Sustainable Finance Disclosure Regulation, or SFDR. This set of rules intends to create a single set of metrics that can be used by all fund managers and investors to evaluate the ESG impact of a specific fund. All fund managers – regardless of whether the fund is marketed as ESG or not – must report on those metrics, giving investors a single set of reporting to review when making ESG decisions. This writing’s been on the wall for a while, and fund managers have been gearing up to comply for the last two years.

The primary goal of this set of rules is to reduce greenwashing, the practice of funds marketing non-ESG products with ESG buzzwords. Until recently there was little or no regulation: fund managers could simply build an index fund, slap “Climate Focused” on the name, and market it with little oversight. The effect has been swift: in the last two years ESG fund investments in the EU have dropped from $14 trillion to $12T. This shouldn’t be viewed as a cause for concern, but for celebration – EU investors have been given the chance to get out of investments that may have been marketed to them as something they’re not.

The US, at this point, does not have a similar set of reporting rules or regulations… which brings us to our next topic. The Securities & Exchanges Commission (SEC) in the US created a Climate and ESG Task Force just this March, led by Kelly Gibson. The first stated goals of the task force are focused on enforcement of existing rules: disclosure issues, referrals and tips, and complaints. This looks like the first step, however, toward a similar rule to the EU’s disclosure requirements. Statements in February of this year and the results of an April report from the Division of Examinations indicate that the SEC is especially focusing on ESG marketing, disclosures, and clarity of process.

If this is the first step toward a set of US rules on marketing, evaluation, and reporting in the ESG world we can expect new rules for fund managers, big brokerages, and independent advisors. While the SEC’s current focus is on enforcing existing rules, having a set of uniform and simplified reporting rules helps everyone. Fund managers will be able to provide comparable information and metrics, helping the best among them stand out from the crowd; advisors will be able to comply more easily with regulations and rules rather than trying to navigate the vague and loose rules that exist now; and individual investors will be able to make choices based on reliable information. Despite the lack of clarity in the US markets right now, US investors have poured money into ESG investments, with an increase from $12 trillion to $17 trillion in the last two years, potentially a sign that we’re seeing the same greenwashing that previously afflicted the EU.

So where does the DOL (Department of Labor) get involved? Individual investors may be unaware that the DOL also writes the rules for employer retirement accounts, like 401(k)s and pensions. The bulk of the average American’s investable assets are in these retirement plans, so changes made to retirement accounts have huge effects on the investing landscape. In June of 2020 the DOL began writing a rule regarding ESG investments in retirement plans, with a final rule coming out in October ’20.

The rule presents five simple rules for retirement plan managers, which focus primarily on the selection of investments available in those plans. Fund managers are responsible to the plan’s participants (you, the worker and investor) first, and are held to a high standard. These rules reinforce that standard, with the aim of preventing managers from including investments based solely on “non-pecuniary” factors, which here means ESG metrics. Essentially the DOL doesn’t want 401(k) fund managers pushing individuals into ESG investments that may be more expensive, higher risk, or poor performers.

The exception carved out by the DOL is that these non-pecuniary factors don’t disqualify an investment from inclusion in the plan, they simply can’t be the sole reason for inclusion in the plan. That means that ESG investments with strong track records of performance, risk management, and expense can still be offered, which seems on the surface like a win for investors. The issue here is one of restriction, the same problem with any limited menu of investment options. Plan managers are responsible for catering to the lowest common investing denominator, ensuring that the presented options are appropriate for all plan participants. That could be thousands, or tens of thousands of individuals, each of whom is in different circumstances.


It should be stated: this rule is not poorly thought out, or intended to create red tape. There are plenty of participants that will benefit by it, and restrictions like these make retirement savings safer for the majority of savers. The problem, such as it is, is that a restricted menu of funds will never be the best option for a dedicated investor (or one with a good manager). Building the most efficient portfolio possible requires access to a broad variety of investment options, in addition to the time and skill to manage the portfolio.

This rule is intended to prevent fund managers from making choices that benefit the environment at the cost of plan participants’ financial health, but that’s precisely what many clients wish to do. Many, many investors are willing to accept a fraction more risk, a quarter-percent poorer performance, or a price increase of a few hundredths of a percent in exchange for halving their carbon footprint, eliminating human rights abuses from their portfolio, or supporting diversity in major companies. These choices have to be taken into account as well as portfolio performance and costs when investing, and the ultimate choice should rest with the investor.

While it’s rarely wise for an individual to move funds out of a retirement plan before leaving an employer, this new rule creates additional incentive for investors to get their funds under direct control when they’re able. This might be at retirement, upon reaching a specific age, or when leaving an employer. We hope that in the future more and more plan administrators find a way to balance ESG concerns and the best interests of plan participants, but for the time being an ESG-conscious investor may struggle to align the bulk of their wealth with their own beliefs.

Each of these topics is worth investigating entirely on its own, and altogether they make it a difficult time to navigate the ESG environment. The key takeaways here are:

  • The EU’s new rules simplify and clarify ESG reporting rules for fund managers

  • EU investments in ESG funds have dropped, indicating that ‘greenwashed’ funds may be losing investors

  • The SEC is cracking down on infractions of current rules surrounding ESG disclosures and sales

  • This might indicate that the US will soon have similar reporting rules to the EU, providing greater clarity to both investors and advisors

  • The DOL’s new rules on ESG investments in 401(k)s aim to protect investors, but may do so at the cost of ESG options available in your retirement plan

  • ESG-conscious investors may have greater incentive to move their money from their 401(k)s to their IRAs

As always, we believe that making good investment choices requires an awareness of the environment, and knowing your own goals. If you’re considering how these changes might affect you, or how you might incorporate ESG investments into your own portfolio, let us know. We’re passionate about bringing your investments into alignment with your best interests, and we have a wealth of knowledge to help you make these choices.

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This series of topical articles is intended to provide general information. For more details on the subject, or to find out how these securities and strategies fit into your plan, reach out to one of our financial advisors.

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