One in four of every professionally invested U.S. dollar is tied to environmental, social and governance criteria. But the Trump administration’s latest proposed rule change may make it harder for ESG funds to attract interest from retirement plans.

On June 23, the Labor Department led by Secretary Eugene Scalia proposed an update to the Employee Retirement Income Security Act of 1974 (ERISA) that would require those overseeing pension and 401(k) plans to always put economic interests ahead of “non-pecuniary” goals.

The agency specifically called out ESG investing in its proposal.“After years of the Department of Labor having varying degrees of guidelines about if you can consider ESG factors, they are coming out definitively to say it’s not appropriate to consider,” said attorney Josh Lichtenstein, a partner in Ropes & Gray’s ERISA practice.

That means that fiduciaries of pension and 401(k) plans could be forced to prove they selected investments based only on economic criteria. “This could actually make it harder for a fund that is advertising as an ESG fund to be selected by these types of plans, even when the selection is truly based on investment performance,” Lichtenstein said.

The move could also create confusion for asset managers throughout the market who have increasingly incorporated ESG into their decision making. Indeed, while ESG investments have been increasingly outperforming, and thus justifiable both on financial and planet-friendly levels, new red tape created by the Trump administration rule may dissuade fiduciaries from incorporating them.

“This is utterly out of step with where investors are going,” said Lisa Woll, chief executive of the US SIF Foundation, an industry group for sustainable and responsible investing. The organization said more than US$12 trillion in U.S. assets are now invested in funds that incorporate ESG criteria. 

“This is not just unnecessary rulemaking, but it’s damaging to the interests of long-term investors.”

For years, ESG funds have been popular with pension plans that have long-term funding obligations. Managers of those plans have often concluded they have a fiduciary duty to include sustainable investing to offset climate change risks, and ensure that plan participants have a livable future in which to spend their pensions.

But ESG funds have struggled to get included in conservative 401(k) plans, with less than one per cent of assets in those plans currently sitting in sustainble funds. Millennials and younger workers in particular have pushed companies to allow more ESG funds into their 401(k) plans, but the proposed Labor Department rule will create an extra hurdle for employers.

In its proposal, the Labor Department said that it wouldn’t be appropriate to select an ESG fund as a default investing option for plan participants. The department declined to immediately comment on the proposal, which will be open for public comment for 30 days and could eventually be challenged in court.

Ironically, investors have had plenty of economic reasons to go into ESG assets this year, as the funds see steady inflows. A study from BlackRock Inc. found that in the first-quarter’s coronavirus-induced crash, 94 per cent of sustainable indexes outperformed traditional indexes. 

“This is not just unnecessary rulemaking, but it’s damaging to the interests of long-term investors,” Woll said. “This document makes the assumption that ESG funds are not aligned with ensuring plans have good financial performance, but that is out of step with the market.”