As Joe Biden’s incoming administration takes shape, many financial advisors are looking to see how he approaches securities regulations, from reexamining Regulation Best Interest to putting a potential hard stop on the Trump administration’s DOL fiduciary exemption, should it ever be finalized.
That includes his administration's view on environmental, social and governance-based investing, which may stand in stark contrast to President Donald Trump's largely skeptical view. In Trump’s final year in office, the DOL and SEC sought to limit financial professionals’ ability to incorporate ESG funds and analyses into their recommendations. For instance, at the SEC, the commission approved restrictions on when and how shareholders could submit proxy resolutions, many of which recently have pertained to ESG issues and oversight. And at the DOL, a recently finalized rule could limit the use of ESG funds in plans protected by ERISA (though the final rule walked back some of the more stringent aspects of the proposal).
The DOL's rule has been finalized, meaning the Biden administration can’t reverse it. But at the last minute, the department specifically excised the term ESG from the language of the rule in favor of a mandate that fiduciaries focus only on "pecuniary" factors in recommendations, as opposed to "non-material" factors around the company's impact on the environment or society.
That omission gives the incoming administration options to interpret the rule differently, according to Aron Szapiro, the director of policy research at Morningstar and the co-author of a recent Morningstar report on potential regulatory developments in sustainable investing.
“Because they took the term ESG out of the rule, there’s a lot you can do with subregulatory guidance,” Szapiro said. “The preamble in the final rule is pretty harsh, but it’s just a preamble.”
Szapiro believes subregulatory guidance, like FAQs and advisory opinions, could clarify that ESG factors can be considered financially material and the DOL would be less skeptical of ESG funds that offer ancillary benefits.
The biggest hurdle for ESG proponents in the final rule was a prohibition on funds that weigh nonpecuniary considerations to be a plan's qualified default investment alternatives—or the funds that are automatically selected for a participant who does not select one themselves. But in their report, Szapiro and co-author Jon Hale note that this part of the rule has a delayed enforcement date, giving the Biden administration time to complete its own rule to counteract it.
But that does not mean it will. Szapiro said the industry was growing tired of the ESG whiplash with guidance from different administrations vacillating between support and skepticism around ESG.
“The question here is can Congress amend ERISA to settle this argument?” he said. “But the industry’s said, ‘enough already.’”
At the SEC, Szapiro speculates that a 3-2 Democratic majority of commissioners would push forward on requiring public companies to disclose climate financial risks, and could even require “mandatory disclosures to include all financially material social and environmental risks.”
In recent weeks, Commissioners Allison Herren Lee and Caroline Crenshaw both criticized recent SEC rule-making for not addressing climate risk disclosures, while Sen. Elizabeth Warren questioned outgoing SEC Chair Jay Clayton about the lack of a uniform process of climate disclosure during a Senate hearing last week. In his testimony, Clayton stressed his belief that standardization has to be approached on a “sector-by-sector” basis and reiterated that stance in a speech last week to The Economic Club of New York.
“It is important that this disclosure be “decision-useful” (i.e., material). In other words, that it provide investors with the ability to incorporate this information regarding the current and future performance of the issuer into their investment decision process,” he said. “It has often been noted that this process can be more efficient if disclosure is standardized or uniform. However, standardization can be difficult across industries, and in particular, with respect to forward-looking information, it can be vexing as it requires uniform assumptions about the future.”
Szapiro acknowledged that a 3-2 Democratic majority would likely revisit the rule-making on shareholder resolutions, if they can get a fifth commissioner and new chair nominated by Biden through a divided Congress.
Unlike executive agencies, “there is an incentive to block nominees to independent commissions,” he said. “These agencies have a lot of power, and personnel is policy.”
