What Is the Sustainable Investment Rule?

Sustainable investing, which considers environmental, social, and governance (ESG) factors, has become a significant focus in investment management. Regulatory bodies often issue guidance to clarify investment strategies. This article explains a specific regulatory framework for sustainable investing.

Understanding the Sustainable Investment Rule

The “Sustainable Investment Rule” refers to the U.S. Department of Labor’s (DOL) regulation, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” Effective January 30, 2023, this rule clarifies that fiduciaries of retirement plans governed by the Employee Retirement Income Security Act of 1974 (ERISA) may consider climate change and other ESG factors when making investment decisions and exercising shareholder rights.

This regulation addressed confusion from prior guidance, particularly a 2020 rule that emphasized “pecuniary factors” and discouraged ESG. The 2020 rule, “Financial Factors in Selecting Plan Investments,” generally required fiduciaries to base investment decisions solely on financial considerations. Varying interpretations of DOL guidance led to uncertainty.

The 2023 rule clarifies that a fiduciary’s duty of prudence can incorporate factors relevant to a risk and return analysis, including economic effects of climate change and other ESG considerations. ESG factors are integral to understanding investment risks and opportunities. The regulation explicitly removed “pecuniary factors” to encourage consideration of financially relevant ESG factors.

The rule also reinstated a “tie-breaker” standard, allowing fiduciaries to consider collateral benefits, such as ESG factors, when competing investments equally serve the plan’s financial interests over an appropriate time horizon. This contrasts with the 2020 rule’s stricter requirement that investments be “economically indistinguishable” before non-financial factors were considered. While the 2023 rule aimed for clarity, May 2025 developments indicate the DOL may engage in new rulemaking, potentially signaling a more restrictive stance on ESG for ERISA plans.

Fiduciary Responsibilities Under the Rule

The rule applies to fiduciaries of ERISA-covered retirement plans, such as pension funds and 401(k) plans. Fiduciaries have duties of prudence and loyalty to plan participants and beneficiaries. Loyalty requires acting solely in participants’ interest for providing benefits. Prudence mandates investment decisions be made with care, skill, and diligence a knowledgeable person would use.

The rule clarifies that considering ESG factors can align with these duties, especially when relevant to an investment’s financial risk and return. Fiduciaries must still focus on relevant risk-return factors and cannot subordinate participants’ interests by sacrificing returns or taking on additional risk for non-financial objectives. ESG considerations are permissible when they contribute to the plan’s financial interests.

For participant-directed individual account plans, such as 401(k)s, the rule clarifies that fiduciaries do not violate their duty of loyalty by considering participants’ non-financial preferences when creating a menu of prudent investment options. This is permissible if accommodating these preferences could lead to greater participation and higher deferral rates, enhancing retirement security. The rule does not mandate ESG consideration, but removes barriers when factors are financially relevant.

The rule addresses the exercise of shareholder rights, such such as proxy voting, affirming these actions are fiduciary acts subject to ERISA’s prudence and loyalty requirements. Fiduciaries should vote proxies unless imprudent. Active ownership, informed by ESG considerations, can be part of a fiduciary’s responsibility to protect and enhance plan assets.

Implementing Sustainable Investment Strategies

Implementing sustainable investment strategies under the DOL’s rule requires fiduciaries to integrate ESG considerations within their existing framework of prudence and loyalty. This involves assessing how ESG factors, such as a company’s carbon emissions or labor practices, might impact its long-term financial performance. Fiduciaries should ensure that any ESG-related analysis is part of a comprehensive risk and return assessment, rather than an isolated consideration.

Fiduciaries can approach ESG integration through various methods, including using ESG data to enhance financial analysis, engaging with companies on ESG issues, or selecting investment products that manage ESG risks and opportunities. Due diligence is paramount, requiring fiduciaries to evaluate how an investment manager incorporates ESG factors and whether this integration aligns with the plan’s financial objectives and fiduciary duties.

Documentation of the decision-making process is important for compliance. Fiduciaries should maintain clear records demonstrating how ESG factors were considered in their investment analysis, particularly when utilizing the tie-breaker rule. This documentation illustrates decisions were made with prudence and loyalty, solely in the financial interest of plan participants. Ongoing monitoring of investments, including their ESG performance and financial impact, is necessary to ensure adherence to fiduciary standards.

While the rule permits the consideration of ESG factors, it does not require fiduciaries to adopt specific ESG-themed investments or strategies. The emphasis is on flexibility and ensuring that any consideration of ESG factors contributes to the financial well-being of the plan. This framework allows fiduciaries to adapt to evolving market practices and participant interests while upholding their core responsibilities to safeguard retirement savings.