BLK BlackRock Inc

By Dieter Holger

The U.S. Department of Labor issued a rule that could curb investing in 401(k)s based on environmental and social issues, a measure that was opposed by money managers who are rapidly building out environmental, social and governance funds to meet rising demand.

First proposed in June, the final rule published on Friday requires that funds in retirement plans only consider risk-and-return for stocks and bonds and not other environmental or social issues. Sustainable funds often target greenhouse gas emissions, labor practices or gender and race relations.

"This rule will ensure that retirement plan fiduciaries are focused on the financial interests of plan participants and beneficiaries, rather than on other, non-pecuniary goals or policy objectives," said U.S. Labor Secretary Eugene Scalia.

Still, a senior department official said funds that consider environmental and social issues could be allowed if managers document how the strategy benefits the core risk-and-return objective.

"This does not mean that fiduciaries are prohibited from considering such issues as environmental impact and workplace practices," the official said.

There could be also "rare circumstances" that an investment with environmental or social goals is indistinguishable economically from a competing option. In those cases, a fund manager could weigh those factors but must show how the financial interests of savers aren't sacrificed.

Only one of the 86 asset managers who sent letters over the 30-day comment period supported the rule, according to an analysis by trade group US SIF: The Forum for Sustainable and Responsible Investment and other organizations. The report found that 95% of 8,737 comments opposed the proposal.

Many said the proposal singles out sustainable investments unfairly for heightened scrutiny, unnecessarily burdens investment firms and is based on a flawed idea that sustainability factors sacrifice returns.

"The proposal creates an overly prescriptive and burdensome standard," BlackRock Inc., the world's largest money manager, said in its comment to the department.

Sustainable funds, typically based on environmental, social and governance data that companies report, are still sparse in retirement plans, but big money managers--like Fidelity Investments Inc. and Natixis SA--have said they want to offer more of the funds to savers.

In 2018, only 2.8% of 401(k)s offered an ESG fund in their lineups, representing a largely untapped market for fund managers, according to the American Retirement Association's Plan Sponsor Council of America, a trade group.

Despite the novelty of sustainable investments in 401(k)s, individual investors are buying into the funds. In the third quarter of this year, the U.S. saw a record $9.8 billion flow into sustainable funds, bringing total assets to $179.1 billion.

"Today's decision is unwelcome by pension funds and other fiduciaries and runs counter to global market trends and the mainstream U.S. and global practice of integrating ESG factors into investment decisions," said Mindy Lubber, chief executive of sustainable investing nonprofit Ceres, which hosts a network of 175 investors representing $30 trillion.

"This decision will impair the ability of pension funds to consider the short- and long-term financial risks posed by extreme weather, water shortages and human rights abuses in performing their investment analysis and allocations," she added.

Analysts said the rule could be reversed, depending on the outcome of next week's U.S. presidential election.

"The ESG pendulum appears to swing based on which political party occupies the White House," said Vadim Avdeychik, a lawyer specialized in investment management at Paul Hastings LLP.

Write to Dieter Holger at dieter.holger@wsj.com; @dieterholger

(END) Dow Jones Newswires

October 30, 2020 16:49 ET (20:49 GMT)

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