The US Department of Labor recently published a proposal aimed at slowing the growth of ESG investing. In particular, they want to rewrite the QDIA rules so that there is, in effect, a presumption that the pursuit of ESG objectives is incompatible with the pursuit of financial goals.

This proposal would offer no new protection to investors; if the DOL believe that there are cases of fiduciaries sacrificing the best interests of participants to advance other agendas, the existing rules offer plenty of room for them to challenge those fiduciaries. The proposal would, however, create a substantial bureaucratic barrier for the growing majority of the industry who recognise that giving some regard to the quality of a company’s handling of matters like executive remuneration, board independence, pollution, child labor and much more is a basic element of investment due diligence.

The reason ESG is growing is that (a) it is financially impactful and (b) investment does not happen in a vacuum sealed off from the society in which it happens.

This is increasingly being recognized and welcomed in other major financial markets. So the DOL’s proposal asserts, in effect, not only that the market is wrong to embrace ESG considerations within mainstream investment processes but also that other regulatory bodies around the world are wrong to encourage this trend.

As the UN PRI report Fiduciary Duty in the 21st Century notes, “globally, there are over 730 hard and soft-law policy revisions, across some 500 policy instruments, that support, encourage or require investors to consider long-term value drivers, including ESG issues.” Almost all of these have come in to being in the past twenty years.

This regulatory trend is based not only on the view that a long-term responsible mindset is not harmful – and almost certainly beneficial – for end savers. It also reflects the broader duty of the regulator to structure markets to achieve the overall best outcome for society as a whole. Adam Smith’s invisible hand does not work by magic. There is a long list of actions that can be taken – whether by individual citizens, by corporations or by investors – that benefit them while imposing costs on others. The technical term by which economists refer to these costs is “externalities”. That’s why we need laws and social norms against government officials accepting bribes, against companies polluting public lands, against investors laundering illegal drug money. These – and many other behaviors – are in one person’s best interest (in the short term at least) but detrimental to the overall good. One of the most important things that good regulators do is to minimize any misalignment between individual incentives and the wider good.

For that reason, most regulators welcome and encourage a long-term responsible mindset among investors. Most regulators do not see their biggest challenge as being that investors and the investment industry are insufficiently focused on short-term maximization of profit. They aren’t worried that Goldman Sachs are about to take their eye off the bottom line. 

So when the DOL states that it “does not believe that investment funds whose objectives include non-pecuniary goals—even if selected by fiduciaries only on the basis of objective risk-return criteria consistent with paragraph (c)(3)—should be the default investment option in an ERISA plan”, it strikes the wrong note for me. They should, rather, be saying that “if it’s possible to fully look after investor’s interests while also playing a positive role in the broader social good, we’re all for it.” 

There are echoes here of an old argument about whether, as Milton Friedman asserted, “the social responsibility of business is to increase its profits”, no more and no less, or whether (as most now believe) there’s more to it than that. As Peter Drucker put it “any institution exists for the sake of society and within a community. It, therefore, has to have impacts; and one is responsible for one’s impacts.” Drucker, to be clear, was not against making money. He was simply recognizing the wider context in which money is made. 

The situation with investment – especially for a product such as a Qualified Default Investment Alternative, which investors are placed into by others rather than deliberately choosing for themselves – is made thornier by the fact that decisions are being made by one person (the fiduciary) on behalf of another (the beneficiary).

When it comes to my own money, nobody would question my right to decide to pursue a goal of maximizing my financial return, while also seeking to avoid where possible negative externalities such as pollution, corruption and so on. However, if I’m acting on someone else’s behalf, I have to be more careful; it’s right to be cautious when dealing with other peoples’ money. But the reason for the caution is not that the broader social goal is a bad thing. Investors are part of a community, too. The real challenge is finding a way to encourage responsible long-term behavior without undermining the financial interest of beneficiaries. That’s why, globally, there are so many regulations being created to support long-term responsible investing.

The DOL seem to believe that this is not possible. That’s like arguing that corporations cannot be responsible for their impacts without sacrificing their desire to make profits, or that acts of individual good citizenship should be treated with suspicion rather than encouraged. 

Instead, they should be exploring ways that it can be done. That’s what the rest of the world is trying to do.