Trump’s Plan to Block Pensions From ESG Won’t Help Fossil Fuels
(Bloomberg) -- The U.S. Department of Labor is concerned that America’s pension fund managers don’t know what they’re doing.
That’s the rationale, at least, for the department’s newly proposed rule restricting the use of environmental, social, and governance considerations in investment decision-making. The language reaffirms the standard interpretation of fiduciary guidelines that only financial risks and returns can be considered in the management of U.S. employer-provided pension funds; “non-pecuniary goals,” for example relating to political or public policy, should not guide pension investments.
The move has been widely interpreted as an attempt by the pro-fossil fuel Trump administration to shore up support for an industry that’s rapidly losing popularity with investors. The timing is ironic, coming as the fossil fuel industry begins to confront existential questions about its near-term future. It would almost be amusing if it wasn’t for the fear, uncertainty, and doubt the proposal leaves in its wake.
Before the pandemic, investors were already growing wary of fossil fuels. Thermal coal’s part in global capital markets has shrunk dramatically, and even the ample dividends paid by Big Oil were coming under pressure as growth opportunities seemed far from guaranteed. Covid-19 accelerated the challenges faced by the oil industry, shutting down some key sources of demand growth such as aviation and shipping. Advances in fuel efficiency, renewable energy technology, and energy storage have continued apace.
Markets tend to be forward-looking. So as doubts grow about the prospects for fossil fuels, financing becomes more difficult and more expensive to obtain. This situation naturally alarms the industry’s supporters. In April, for example, 17 Republican senators wrote to Federal Reserve Chairman Jerome Powell and Treasury Secretary Steven Mnuchin to ask that fossil fuel companies’ debt not be excluded from the Fed’s asset purchasing programs designed to shore up the economy in the middle of the pandemic.
It’s true that some, if not most, of the decisions by institutional investors to reduce their holdings of fossil fuel stocks probably originated from something labelled “ESG.” It’s also true that, as the Department of Labor points out, ESG is a poorly-defined term. The acronym is sometimes used interchangeably with other strategies such as “responsible investing” or “ethical investing,” which are designed to incorporate non-financial beliefs, such as excluding armaments manufacturers, into investment decisions.
The majority of ESG products these days have a goal that’s almost the exact opposite: To improve the financial performance of a portfolio by assessing things such as environment-related risks and opportunities. There are frequent references in ESG to “materiality,” another term for financial impact; in most cases materiality isn’t an added bonus but rather a threshold for inclusion.
The Department of Labor’s proposed rule also seems to cling to the notion that ESG strategies underperform, despite plenty of research showing that’s not the case. A study for the U.N. Principles for Responsible Investment last year found that ESG-focused portfolios actually outperformed the MSCI Index over a 10-year timeframe, and an IMF analysis last October found no evidence of underperformance.
To exclude consideration of something as pervasive as, say, the environment from financial decision-making assumes the world is like a simple Microeconomics 101 model. In such a world, competition is pure, foresight is perfect, and things like policy and technological development don’t exist. This doesn’t sound like a sensible basis for managing someone’s retirement savings in the real world.
Exhorting pension fund managers to focus more strictly on financial returns should, rationally, make an argument for ESG investing, or at least for considering these sorts of strategies more broadly. But the Trump administration’s new rule adds to the burden of proof, requiring pension fiduciaries to demonstrate that any ESG fund has exactly the same profile as a non-ESG alternative and setting out higher expectations on how to document “tie breaker” decisions in the event that an exact match is found.
The Department of Labor estimates that most ESG funds are already effectively in compliance, but the approximately 30,000 that aren’t will have to spend about 600 hours or $57,000 fulfilling the new requirements. Faced with the prospect of more detailed documentation for their decisions, some might simply feel it’s easier to avoid ESG altogether.
It’s not surprising that rule might have a “chilling effect” on pension fund managers wanting to use ESG investing or make it available to their members, as Lisa Woll, CEO of U.S. Sustainable Investment Forum, told Responsible Investor, a trade publication. The fear and dread that such regulatory overhead creates might make fiduciary duties subservient not to “non-pecuniary goals” nor to financial returns, but rather to the political priorities of the Trump administration.
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