Mandated DOL review of energy sector investment trends and proxy voting guidance may contribute to ESG Market Confusion
On April 10, 2019, President Trump issued an Executive Order intended to promote investment in domestic energy infrastructure. The Executive Order on Promoting Energy Infrastructure and Economic Growth emphasizes the importance of efficient and timely permitting, best practice regulations, and "support for American ingenuity, the free market, and capitalism" in expanding and accelerating access to the country's energy resources. (See attached Executive Order.) As part of its promotion of energy infrastructure investment, this Executive Order also includes a section on environment, social and governance (ESG) issues, which directs the Department of Labor (DOL) to assess energy sector investment trends of retirement funds as well as existing DOL proxy voting guidance related to retirement plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). See Section 5. DOL is to complete both reviews within 180 days and provide potential recommendations.
Like the unexpected DOL guidance document on ESG investment released a year ago, the recent mandate to DOL may give rise to concerns and uncertainty about the risks associated with ESG investments and proxy engagement with potential unclear impacts on those activities. Given the substantial retirement plan stake in ESG funds, even a relatively small shift by some plans could affect market interest in individual companies especially if the broader investment community responds to retirement fund directional moves.
Irrespective of the actual feasibility of enacting specific ESG proxy or investment regulatory incentives or constraints, some pension fund managers may conclude it is safer to forego possible future added scrutiny surrounding the decision to invest in ESG funds or to engage in related proxy efforts by simply avoiding those activities. Some funds may choose to press corporates for more information about ESG performance and valuation to ensure they have satisfied their investment fiduciary duty, thereby further burdening company reporting and disclosure. Other managers may maintain their aggregate ESG investment ratios but elect to reassess and readjust the specific companies in their portfolios. Each of those or other outcomes could affect not only retirement fund investments, but also the underlying companies in those portfolios. In short, because the consequence of the DOL process is uncertain and unclear, corporate, investment community and retirement plan interests may wish to consider whether and how to engage with DOL on the ESG mandated reviews.
The April 23, 2018 DOL ESG Bulletin
A year ago, DOL issued Field Assistance Bulletin (FAB) 2018-01 (April 23, 2018) to the Employee Benefits Security Administration's national and regional offices. Pursuant to ERISA, DOL is charged with certain oversight and regulatory responsibilities related to the operation and management of retirement plans subject to ERISA jurisdiction. In releasing FAB 2018-01, DOL explained that the document was intended to clarify the application of two previous DOL guidance documents - Interpretive Bulletin 2016-01 (regarding the exercise of shareholder rights and written statements of investment policy) and Interpretive Bulletin 2015-01 (regarding economically targeted investments or ETIs) - to ESG investing and related ESG shareholder engagement. In the FAB 2018-01, DOL acknowledged that there are instances when ESG issues can give rise to material economic considerations. However, the Department cautioned that ERISA-plan fiduciaries "must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision." The Department emphasized that ERISA fiduciaries must always prioritize the financial factors that have a material effect on risk and return, reiterating its "longstanding view" that plan fiduciaries may not sacrifice investment returns or take additional investment risk in order to promote "collateral social policy goals." While many commentators viewed DOL's statements as restating well-recognized fiduciary responsibility principles, others construed FAB 2018-01 as an implied threat intended to slow pension fund capital flow to ESG funds.
That latter view was heightened somewhat by the seemingly clearer admonition in FAB 2018-01 regarding pension fund management engagement in ESG related proxy activities. FAB 2018-01 directly addressed proxy voting and other types of shareholder engagement, stating that DOL's prior guidance was "not intended to signal that it is appropriate for an individual plan investor to routinely incur significant expenses to engage in direct negotiations with the board or management of publicly-held companies . . . or to fund advocacy, press or mailing campaigns on shareholder resolutions, call special shareholder meetings, or initiate or actively sponsor proxy fights on environmental or social issues relating to such companies." Indeed, FAB 2018-01 indicated that a cost-benefit analysis may be warranted before the ERISA plan fiduciary actively engages on ESG issues. Between the fiduciary duty reminder and the proxy engagement warning, some observers anticipated that ERISA retirement plan managers might retreat from ESG investment or proxy engagement. Nonetheless, while some individual fund retrenchment may have occurred, overall market ESG investment and proxy engagement increased in the past year, leading in the aggregate to greater engagement with and demands on public companies, as well as producing somewhat differing market valuation implications for individual companies.
The April 10, 2019 Executive Order
Against this background, some analysts will interpret the ESG mandate in the Executive Order as a renewed effort to chill the ESG investment market, and in particular, to rebalance pension fund (and other investment) back towards traditional energy funds and projects, as well as to alleviate the growing burden on companies related to the expanding level of ESG related proxy activity. Section 5, which is titled "Environment, Social and Governance Issues; Proxy Firms; and Financing Energy Projects through the United States Capital Markets," stresses that the US capital markets are grounded in the fundamental notions of materiality (i.e., a substantial likelihood that a reasonable shareholder would consider the information important) and fiduciary duty (i.e., an obligation to maximize return). Presumably to advance these principles, the Executive Order directs the Secretary of Labor to review "available data filed with the Department of Labor by retirement plans subject to [ERISA] in order to identify whether there are any discernable trends with respect to such plans' investments in the energy sector." DOL has 180 days to complete this review and must report back on its findings.
Further, the Executive Order also establishes a 180-day deadline for the Secretary of Labor to "complete a review of existing Department of Labor guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets." Although the directive does not explicitly reference ESG proxy voting, notably the mandate is located in the ESG Section. Accordingly, it is reasonable to expect that the 180 day review will lead to specific proposals regarding ESG proxy engagement by pension funds.
Engagement with the DOL review may merit consideration
While the April 23, 2018 DOL Bulletin seemingly failed to slow either ESG investment or ESG proxy activity, this latest foray into the arena may have a differing effect, and may signal to investors and specifically to ERISA retirement fund managers that the ESG world will be of continuing interest to the Trump Administration. The consequence of that interest is both difficult to predict and likely to vary among individual companies, retirement funds and investors. In that the scope and nature of the impact may be materially shaped by the outcome of the specific DOL related mandates, companies, retirement plans and investors alike would be well advised to consider tracking if not engaging with the ongoing DOL processes to ensure they understand and address the potential issues of interest to them.