Retirement Plan Investing:
Clearer Information on Consideration of Environmental Social and Governance Factors Would Be Helpful
GAO-18-398: Published: May 22, 2018. Publicly Released: May 22, 2018.
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What GAO Found
Few retirement plans in the United States incorporate environmental, social, and governance (ESG) factors into their investments according to available data. ESG factors that may affect investment returns include climate risk, executive compensation, and workplace safety issues among others. According to GAO's interviews with seven asset managers, inconsistent data and regulatory uncertainty create challenges to incorporating ESG factors in plan investment management. However, those plans considering ESG factors use various strategies to do so (see figure). Asset managers and plan representatives said they incorporate ESG factors to better manage risks and improve performance.
Strategies Used to Incorporate ESG Factors into Investment Management
The retirement plans GAO reviewed in France, the Netherlands, and the United Kingdom (UK) reported using integration and other strategies to incorporate ESG factors across their investments, particularly to address the risk of climate change. For example, the UK's National Employment Savings Trust—a defined contribution plan—used an ESG integration strategy in developing its default fund for participants who are automatically enrolled and do not select another investment. As part of their ESG strategies, representatives from these plans described targeted efforts to address climate risk related to financial performance. These representatives also said they are subject to governmental policies that encourage plans to address ESG risks.
In the United States, the Department of Labor's (DOL) guidance for private sector plans identifies ESG factors as proper components of investment analysis, but does not fully address uncertainties plans may face. In particular, sponsors of defined contribution plans face uncertainty about whether they may use ESG factors in a qualifying default fund—a widely used option in which a fiduciary is generally not liable for investment losses. DOL's mission includes assisting and educating plan fiduciaries. Providing clearer information about how to use ESG factors would help fiduciaries better understand whether and how to consider these potentially material risks. DOL is also considering steps to collect data on the use of ESG factors by retirement plans.
Why GAO Did This Study
ESG factors have emerged as a way for investors, such as retirement plans, to capture information on potential risks and opportunities that may otherwise not be taken into account. For example, climate change is expected to have widespread impacts according to a key federal study and may pose significant financial risks for long term investors, such as retirement plans that must manage risk to provide benefits for many years to come. A number of large plans in other countries have adopted ESG strategies, but less is known about their use among U.S. plans. Given the emerging use of ESG factors, GAO was asked to examine how such factors are used by retirement plans in the United States and other countries.
GAO examined: (1) the use of ESG factors by U.S. retirement plans, (2) the use of ESG factors by selected retirement plans in other countries, and (3) DOL's guidance on the use of ESG factors by private sector U.S. retirement plans. GAO reviewed available private sector survey data and other documentation and interviewed government officials, asset managers, and plan representatives in the United States, France, the Netherlands, and the United Kingdom—from retirement plans that were identified as leading examples in the use of ESG factors.
What GAO Recommends
GAO is making two recommendations to DOL, including that DOL clarify whether the liability protection offered to qualifying default investment options allows use of ESG factors. DOL neither agreed nor disagreed with GAO's recommendations.
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Recommendations for Executive Action
Comments: DOL neither agreed nor disagreed with this recommendation. On April 23, 2018, while DOL was reviewing our report, the agency issued Field Assistance Bulletin 2018-01 regarding retirement plans' use of ESG factors. While this new bulletin specifically mentions the use of ESG factors in a QDIA and reiterates the conditions under which an investment option may generally be considered a QDIA, it focuses on the use of ESG factors for collateral benefits rather than on cases where ESG factors are considered in investment decisions because they have been determined by fiduciaries to be material to financial performance. For example, the new field assistance bulletin states that the QDIA regulations do not suggest that fiduciaries should select a QDIA based on collateral public policy goals. ESG factors can be used to address material risks, which might otherwise be ignored, and there is interest in considering such factors within a QDIA. The use of ESG factors in this manner can be distinct from pursuing collateral public policy goals. Additional clarification from DOL that explicitly addresses plans' use of financially material ESG factors in investment options designated as a QDIA could enhance the agency's effectiveness in assisting plan fiduciaries with understanding and fulfilling their obligations under ERISA. In June 2019, DOL stated that it would be appropriate to engage with stakeholders before reaching any conclusions about the necessity or appropriateness of issuing further guidance in this area. Additional information about DOL's efforts to engage with stakeholders, including the outcome of such efforts and rationale for any conclusions reached would help determine the effectiveness of the agency's actions.
Recommendation: The Assistant Secretary of Labor for the Employee Benefits Security Administration (EBSA) should clarify whether an Employee Retirement Income Security Act of 1974 plan may incorporate material ESG factors into the investment management for a qualified default investment alternative (QDIA). (Recommendation 1)
Agency Affected: Department of Labor
Comments: DOL neither agreed nor disagreed with this recommendation. GAO believes that while DOL's new field assistance bulletin provides information on the limitations of using ESG factors for pursuing collateral benefits, additional clarifying information could help sponsors conduct due diligence in considering whether ESG factors are material to an investment's financial performance and, if so, how to address those material risks. DOL's written comments recognize that additional clarification could be appropriate, depending on responses to the new field assistance bulletin from the public. We appreciate the consideration of the need for additional information, particularly as some have noted the new field assistance bulletin could create a chilling effect that leads fiduciaries to avoid considering ESG factors that could address material risks in their investments, to the detriment of plan participants' best interests. In June 2019, DOL stated that it would be appropriate to engage with stakeholders before reaching any conclusions about the necessity or appropriateness of issuing further guidance in this area. DOL further stated that the agency added a new project to the Spring 2019 regulatory agenda related to proxy voting. Additional information about DOL's new project on proxy voting and efforts to engage with stakeholders, including the outcome of such efforts and rationale for any conclusions reached, would help determine the effectiveness of the agency's actions.
Recommendation: The Assistant Secretary of Labor for EBSA should provide further information to assist fiduciaries in investment management involving ESG factors, including how to evaluate available options, such as questions to ask or items to consider. (Recommendation 2)
Agency Affected: Department of Labor