How Does The ESG Rule Affect Retirement Funds?

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On Wednesday, the Senate passed a bill that blocks a Biden administration retirement investment rule which allows managers of retirement funds to take into account ESG (environmental, social and governance) factors when selecting investments.

The political tussle over the bill is expected to continue for some time because President Joe Biden is expected to veto the bill. So, before the ESG rule becomes law, it is important for retirees to know if, and how would the ESG rule affect retirement funds.

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What is The ESG rule?

This U.S. Department of Labor rule came into effect on January 30. Specifically, the rule lifts the restriction to ESG investing that was imposed during the Trump administration. A 2020 regulation mandated retirement funds to take into account only financial factors when making investment decisions.

As per the Labor Department, the Trump-era rule failed to consider the positive impacts of ESG investing on long-term returns.

The ESG investment rule, if approved, would allow pension fund managers to take into account ESG factors when making investment decisions. ESG factors include climate change, good corporate governance and other similar factors. In a nutshell, fund managers would screen investments based on socially conscious factors as well.

ESG investing has gained popularity over the past few years. Several companies are now practicing this investment style in order to boost their social and environmental efforts. Such an investment style takes into account non-financial factors in investment decisions, and thus, could ban investing in gun and fossil fuel stocks.

What Do Proponents Say?

Talking about how the ESG rule affects retirement funds, proponents say that ESG factors are relevant to financial returns because investments based on climate change risks can eventually impact profits.

“This isn’t about ideological preference — it’s about looking at the biggest picture possible for investors to minimize risk and maximize returns,” Majority Leader Chuck Schumer said on the Senate floor on Wednesday. “Why shouldn’t you look at the risks posed by increasingly volatile climate incidents?”

Moreover, supporters of the ESG rule also argue that this rule is not a mandate, meaning, it allows consideration, but is not a required rule.

“…the 2022 rule is not a mandate – it does not require any fiduciary to make investment decisions based solely on ESG factors,” read the statement of administration policy

What Do Opponents Say?

Republicans criticize ESG investing, arguing that financial institutions should not use their authority to invest in so-called woke political agendas, rather the fund managers should focus solely on maximizing returns.

“The Biden Administration wants to let Wall Street use workers’ hard-earned savings to pursue left-wing political initiatives,” Senate GOP leader Mitch McConnell said in remarks on the Senate floor on Tuesday.

A lawsuit (by 25 Republican-led states, an oil drilling company and an oil and gas trade group) seeking to block the ESG rule completely, argues that it would undermine “key protections for [the] retirement savings" of 152 million workers by shifting a focus on "woke" social rules, rather than financial returns.

Further, the lawsuit claims that the ESG rule is in conflict with tax and labor law that require fund managers to act in the best interest of their clients and put clients' interests above all.

Republicans, however, do say that their main objective is to prevent fund managers from basing their investment decisions primarily on ESG factors, and not stopping funds from considering ESG issues altogether.

How Does ESG Rule Affect Retirement Funds?

There is no doubt that ESG-based investing is gaining ground, but exactly how the ESG rule affects retirement funds is something that is hard to tell for now.

A report from PwC estimates that ESG-focused institutional investments will soar to $33 trillion by 2026, making up 21.5% of assets under management.


It is, however, also true that ESG funds took a hit last year primarily due to the Ukraine war and the tumbling financial markets. As well, 2022 was the first time in five years that ESG funds lagged behind non-ESG funds.

In 2022 (as of November), the net outflow from ESG funds (stock, bond and mixed-asset funds) was $13.2 billion. It was the first net outflow from ESG funds since 2011, as per Refining Lipper data.

On the other hand, non-ESG funds also witnessed significant outflows, losing about $420 billion during the same period. Total net assets in ESG funds, however, were down 29% in 2022 (up till November), compared to a 21% drop in non-ESG fund assets during the same period.

Similar to the political community, the ESG rule has divided the business community as well. Industries that stand to lose from the ESG rule, such as the oil and gas industry, oppose it, while many others support making ESG investing easier.

The country's largest business lobby group, the U.S. Chamber of Commerce, doesn’t seem to have a clear stance on the issue either. It was against the Trump administration's restrictions on ESG investing, but it noted last year that the Biden administration rule was largely unnecessary.

What Now?

Now that both the House and Senate have passed the legislation to block the ESG investment rule, it will head to Biden's desk. On Monday, the White House warned that President Biden will veto the bill if it is sent to his desk. If Biden does veto the bill, Congress then would have to pass the resolution again but with a two-thirds majority in both chambers.