What changes could a Biden administration bring to ESG investing?
Will investing with a focus on environmental, social and governance (ESG) factors gain support in the U.S. under the administration of President–elect Joe Biden?
Broadly speaking, we believe the answer is yes—but we don’t expect this to lead to a significant change in ESG integration. To understand why, let’s dig under the surface a bit.
What to expect from a Biden administration
In a nutshell, we believe that the Biden administration will bring to the forefront the investment community’s understanding of ESG, lending more support through regulatory guidance changes and executive orders. In addition, we expect the Biden administration to take a more hands–off approach to regulating the role of ESG considerations in investing, allowing for greater fiduciary discretion and a lower regulatory burden than the current laws and regulations require.
We foresee a reversal in several of the Trump administration’s environmental policies, which could give greater significance to the environmental element of ESG investing. Top among these, likely on Biden's first day in office, is to once again sign the United States onto the Paris Agreement to curb greenhouse gas emissions. It’s important to note, however, that if the U.S. signs the Paris Agreement without Senate approval—as was the case under former President Barack Obama—future presidential administrations could pull the nation out of the accord again, as President Donald Trump did in 2017.
Consistent with this focus on climate change, Biden will also have the opportunity to replace the outgoing Securities and Exchange Commission (SEC) chair. The new chair will likely be tasked with requiring public companies to disclose climate change–related financial risks and greenhouse emissions in their operations. Biden is also likely to appoint a new head to the CFTC (Commodity Futures Trading Commission), with a mandate to increase focus on climate risk management.
As a presidential candidate, Biden made the case for a transition strategy from fossil fuels to clean energy, with specific mention of a stepwise approach to achieve lower carbon while preserving energy supply and energy jobs. This strategy suggests there could be significant material impact to businesses in the energy sector during his tenure. However, the specifics behind these proposals—such as a ban on new fracking on federal land—are unlikely to come together for a while. As such, we believe any potential impact on investment opportunities will remain rather murky for a while.
Turning to the social factor, there are a host of issues in this area that a Biden administration may choose to address, most notably healthcare requirements for U.S. businesses, and racial inequity. For instance, the president–elect has expressed a strong interest in expanding the Affordable Care Act (ACA), including by offering a public, or government–run, option for healthcare. Small or medium–sized companies may be most impacted by such actions as the obligation to provide healthcare may allow them to attract skilled workers from larger businesses but may impose cost changes that are currently unclear. In regard to racial justice, diversity, equity, and inclusion may find more government support over the next few years, though details on how are not clear.
The Biden administration may also wade into the social media landscape, potentially holding social media platforms accountable for content. This, in turn, could impact the bottom lines of social media titans like Facebook and Twitter. In addition, there’s also speculation that the incoming administration may try to level the playing field between online retailers and (often) smaller, brick–and–mortar operations—especially since the COVID–19 pandemic has further accelerated the trend toward online shopping.
It’s important to note that many of these issues would be hard for the Biden administration to address without bipartisan support, assuming that the Republicans retain control of the Senate—an outcome that won’t be known until January, due to two runoff elections in Georgia. That said, Biden could also enact some changes through executive orders. We do see this as a possibility in some areas, such as internet accessibility, where the president–elect may attempt to regulate the internet like a public utility. A more highly regulated environment, in turn, would no doubt have ramifications for the security prices of big tech companies.
Regardless of which way the Senate ultimately swings, cooperation with the Republican Party will be instrumental for Biden in order to tackle, in any sort of permanent fashion, the many promises laid forth during his presidential campaign.
Industry practice v. political climate
In Canada, there have been similar discussions concerning the integration of ESG factors in pension plans, however, the approach in each market will need to take into account local regulatory and legal implications. For example, since 2016, Ontario has required pension plans to file their statement of investment policies and procedures with the pensions regulator and include a disclosure about whether ESG factors are incorporated into the pension plan’s investment strategy and, if so, how.1 In general, the financial industry across North America exhibits an awareness that ESG risks are investment risks. As such, many managers support the belief that ESG factors have a material impact on security prices, as evidenced by the results of our 2020 ESG manager survey. We believe that fiduciaries would be wise to consider these factors in their overall investment desicion making.
Certainly, the materiality of each ESG factor can vary considerably by industry—for example, environmental aspects tend to be more important when evaluating energy companies, whereas governance factors typically matter more when evaluating the tech industry. Regardless, these factors are already ingrained in today’s investment thinking, and we don’t see this changing, irrespective of any alterations to the makeup of the U.S. government.
As proof, look no further than the collective industry response to the U.S. Department of Labor (DOL) proposed rule on regulating ESG investments. In June 2020, the DOL proposed a rule that would have made it more difficult for ERISA (Employee Retirement Income Security Act) plan fiduciaries to incorporate ESG factors into investment decisions. In response, the DOL received more than 8,000 comments from investment firms, industry groups and other stakeholders, the overwhelming majority of which strongly argued against this proposal, noting that ESG factors are investment factors—and that omitting them in an investment process could lead to sub–optimal performance. As a result, the final rule focused less on ESG than the proposal on which it was based.2
These comments aligned strongly with the views on ESG that we’ve long held at Russell Investments. We’re of the mindset that when it comes to ESG investing, it is possible to boost performance without necessarily increasing risks.
Political climate vs. investment culture: ERISA–governed plans will remain cautious
Despite any new regulations or laws enacted by the incoming U.S. administration, ESG investing practices are likely to be influenced by the differing cultural views embedded across the investment landscape.
ERISA–governed retirement plans:
We would be surprised to see a material shift in how corporate pensions in particular think of ESG investing, beyond the integration of ESG factors for performance–only considerations. We believe that fiduciaries of these plans will likely continue to be hesitant when considering ESG–themed investing in their investment processes—even if the goal is to integrate ESG factors solely for performance–focused reasons, as the investment management community continues to do so. Their trepidation is due to ongoing worries within the ERISA sector that any portfolios aligned with ESG–themed initiatives could open the door to potential lawsuits.
The newly finalized DOL proxy voting rules may restrict ESG-related proxy votes. While a Biden administration is likely to reverse anything that gets finalized, the uncertainty associated with these changes reinforces the very cautious view taken by ERISA plan sponsors.
Ultimately, until the DOL or Congress provide plan fiduciaries with clear guidance—and ideally, additional safeguards from litigation—ESG–themed products are unlikely to be widely considered in ERISA–governed plans.
U.S. Non–profit, U.S. retail and non–ERISA retirement plans:
We do think there will continue to be an upward trend in ESG–themed investing in other sectors.
The U.S. non–profit sector has embraced ESG and impact investing this year—in fact, it’s now top–of–mind for some non–profits.
Retail investing in U.S.—where investors can choose from a menu of options themselves—has trended toward a greater embrace of ESG. We believe that the more investors are allowed to direct and choose their own investments, the more will embrace ESG investing.
In fact, Morningstar data that shows a nearly fourfold increase in 2019 over previous year in flows into U.S. sustainable funds, at US$20.6 billion.3
The bottom line
Ultimately, we believe that the outlook for ESG–aware and ESG–themed investing will be more favorable under a Biden administration. Much of this outlook is fostered by trends that will continue across the U.S. investor landscape. With regard to highly regulated ERISA–governed plans, we expect an early emphasis on executive orders and regulatory evolution, fostering a more hands–off approach with a lower regulatory burden than recent guidance suggests. Whether this renewed support for ESG issues becomes deep–seated or fleeting, however, will likely hinge on the ability of the new administration to achieve bipartisan support in the coming years.
1 Strengthening Canadians' Retirement Security: Proposals to Support the Sustainability of and Strengthen the Framework for Federally Regulated Private Pension Plans”, Department of Finance Canada
2 As a result of the outcry, the DOL made several alterations to the proposed rule, notably the removal of any language singling out ESG investments. The department’s final rule, issued December, 11, 2020 reinforced the requirement that U.S. retirement plan sponsors governed by ERISA remain focused on pecuniary—or financially–related—issues and bear the burden of demonstrating a linkage in selecting any ESG–themed product. Further, under the final Rule, ERISA plan fiduciaries must not sacrifice investment, take on additional risk or increase cost in order to promote goals unrelated to the financial interest of the plan participants.