6.5 Pension funds as responsible investors in the United States

The most important pieces of pension legislation in the US are the following. The Employee Retirement Income Security Act of 1974 (ERISA) is the most important law for occupational pension plans in the US.24 The ERISA defines minimum legal standards for voluntary pension plans in the private industry, including rules on reporting, disclosure, participation, funding, fiduciary duties, administration and enforcement.25 In 1978 the Revenue Act established the 401 (k) plans.26 Then in 2001 the Economic Growth and Tax Relief Reconciliation Act is an income tax cut law, it lowered tax rates and simplified retirement plans, as the IRA 401 (k) plans.2728

Later in 2006, the Pension Protection Act of 2006 (PPA) brought the most significant changes to occupational pension plans since 1974. The Pension Protection Act’s main contributions were changes on the funding of defined benefit pension plans, however, it also influenced the operation of defined contribution plans.29

The Social Security Administration is responsible for the administration of the public pension system. The Department of Labor regulates and supervises the occupational pension system.30 The Internal Revenue Service administers the Internal Revenue Code, namely the eligibility, vesting, and funding requirements under the ERISA. The Employee Benefits Security Administration is part of the Department of Labor and it has the responsibility for ensuring the enforcement of the ERISA’s standards covering reporting, disclosure, and fiduciary matters. It is part of the Department of Labor.31

In the US, the prudent person rule is set forth by the Employee Retirement Income Security Act of 1974 (“ERISA”) on Section 404.3233It is part of the judiciary responsibilities to define, interpret and apply the rule.34 However, characterized by solely adopting the prudent person rule, pension funds also have to respect quantitative limitations to their investments.3536Under the prudent person rule, fiduciaries are required to perform their duties “Solely in the interest of plan participants and beneficiaries” and, despite encouraged by the US Department of Labor, they are not required to have an investment policy.37

The Department of Labor has clarified, through the ESG Bulletin, that ESG factors can be part of the “primary analysis” of prudent investment decision-making by the ERISA fiduciaries.38 Under the US law, on Section 404 of the ERISA, the Prudent Person Rule is stated as follows.39

In the US, the discussion of whether there is a conflict of interest between the fiduciary duty and responsible investment is also debated. This debate seems to also be influenced by politics. Given the impact of the discussion nationally but also globally, the US regulators have been compelled to evaluate the implications of the ERISA on the potential conflict between responsible investment and fiduciary duty.4041The Department of Labor (DOL) has the responsibility of interpret and enforce the ERISA’s provisions.42 The ERISA itself did not change since 1974, when it was issued but the DOL has published several bulletins for guidance. In October 2008 the DOL had issued the Labor Bulletin on Economically Targeted Investments (29 CFR 2509.08-1). This Bulletin discouraged investors from considering environmental and social risks and opportunities in investee companies. In October 2015, the US Department of Labor rescinded the bulletin published in 2008 and, in replacement of the latter, published a new Interpretive Bulletin.43 The interpretative bulletin clearly states, “fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors.”4445This measure came to reinforce the ERISA leaving no doubt that fiduciaries may incorporate “ESG-related tools, metrics and analyses to evaluate an investment’s risk or return or choose among otherwise equivalent investments.”46 This is a landmark initiative as privately retirement plans in the US are obliged to follow the fiduciary responsibility provisions of the ERISA in their investment decisions.47 However, in April 2018, the DOL issued a Field Assistance Bulletin updating previous DOL Interpretative Bulletins (namely the one issued in 2015). This Field Assistance Bulletin from 2018 suggests that sustainable investments should be balanced with economic benefits.48 This update may raise the question of whether an ERISA fiduciary may consider ESG factors when evaluating investments for employee benefit plans, voting proxies and exercising shareholder rights.49 This development may, in my opinion, send-out a confusing message to investors. Although this new bulletin from 2018 may be seen as more restrictive, its impact is not yet known.50 Given the threat of climate change, I believe the ESG debate and ESG risk management is here to stay, and besides we should not discard the possibility of a change of direction when there is another presidential shift.51

The CalPERS is the US Public Employee Pension Fund, a health care services provider and insurer located in the state of California, established in 1932 by state law.52 With USD $301,9 billion of assets under management in 2015, €270 billion in 2016.53 It is the largest state pension fund in the US.5455 Given its asset size it is also one of the largest pension funds in the world. In terms of responsible investment, the CalPERS is in the forefront of ESG best practices, it is active in the field, cooperates with organizations such as the Investor Network on Climate Risk (which is under Ceres’ management), the CDP (former Carbon Disclosure Project) and Water Disclosure Project.56 It is also a signatory of the PRI.5758 In 2016 CalPERS adopted a five-year ESG strategic plan,59 which considers to be “the next stage of evolution of CalPERS’ work on sustainable investing”.60 Among others, the five-year plan includes, benchmark and track the progress of integrated reporting globally,61 manage climate risk and opportunity by engaging 80 Montreal Pledge companies62 and Strengthen understanding of ESG factors relevant to risk and return specific to CalPERS’ investment objectives.63 CalPERS has key partnerships with organizations including, CERES, International Corporate Governance Network, UN-supported Principles for Responsible Investment, Sustainability Accounting Standards Board and UN Global Compact.64

Showing its commitment to responsible investment, as part of its investment policy, CalPERS has developed investment beliefs to manage investments and has included ESG concerns.65666768See below.

Research conducted by Kees Koedijk (Tilburg University, CEPR) & Alfred Slager (Tilburg University, Stork Pension Fund), and Rob Bauer (Maastricht University, Netspar) has found that “the beliefs to which a fund adheres affect its success; the thorough consideration of the relationships between beliefs is equally important.”69 Among others, Koedijk, Slager and Bauer (2010) found it “makes sense to explore which strategic investment choices have been made and why”;70 formulating investment beliefs benefits both small and large pension funds.71 These authors define investment beliefs as “assumptions regarding how to view the financial markets and regarding what works best for the organization.”72 Although investment beliefs are implicit in every investment decision or strategy, they are not always made public (Raymond, 2008).73

Given the growing recognition of the relevance of responsible investment and long- term value creation in the US, more organizations active in this field have emerged.74 One example is the US Social Investment Forum (SIF) Foundation’s Center for Sustainable Investment Education, which since 2013, has been active in providing further guidance and education to investment professionals. E.g. the introductory course for investment professionals on the Fundamentals of Sustainable and Responsible Investment. The US SIF often cooperates with the CFA Institute, a global non-profit association of investment professionals, it sets standards for financial professional excellence, providing different programs and giving the Chartered Financial Analyst (CFA) designation. The Institute has taken interest in ESG education and has relevant publications in the subject. E.g. Environmental, Social, and Governance Factors at Listed Companies: A Manual for Investors, published in 2008, giving guidance on ESG factors and fiduciary responsibilities;75 more recently in 2015, published Environmental, Social, and Governance Issues in Investing: A Guide for Investment Professionals.76

Also organizations active globally, such as the CDP, Global Reporting Initiative, International Integrated Reporting Council, Sustainability Accounting Standards Board, UN Global Compact and UN-supported Principles for Responsible Investment have been active fostering responsible investment best practices and dialogue among the responsible investment chain. These organizations offer a wide range of guidance principles, key performance indicators, workshops, courses and conferences on responsible investment and sustainability reporting. Their work is key for raising awareness, developing knowledge, developing soft law national and international agreements and contributes to policy making.77

Finally, in 2016, the UN-supported Principles for Responsible Investment, the UN Environment Programme – Finance Initiative and the Generation Foundation launched a three-year project following-up to the publication of the Fiduciary Duty in the 21st Century Stakeholder Feedback in 2015.78 Part of this project is the publication of roadmaps on policy changes on ESG risk integration in investment practices across eight countries including the US. In the US roadmap (2016) UN- supported Principles for Responsible Investment and Generation Foundation have acknowledged that in the US, ESG integration is growing rapidly given rising client demand for ESG services (US SIF Foundation, 2016);79 there is a need for comparable and material ESG disclosure by investee companies; ESG risk integration by investors in their responsible investment processes and along the responsible investment chain; and “well-framed” regulatory guidance could foster the improvement of governance structures and investment processes.