What Biden’s ESG Veto Means for Investor Choice

President Joe Biden used his first veto on Monday to affirm consumers’ right to access environmental, social and governance, or ESG investments through employer-sponsored plans, such as 401(k) plans. 

Earlier this month, Congress attempted to overturn a Labor Department rule that allows retirement fund managers to consider ESG factors.

The House has scheduled a veto override vote for Thursday, but since overriding the veto would require two-thirds of both congressional chambers to be on board, Biden’s veto will likely be the final word.

What is ESG anyway?

According to a 2022 FINRA study, only 24% of investors can correctly define ESG investing. 

So what is it, exactly? ESG is a framework used to evaluate an investment’s sustainability. Environmental factors look at the conservation of the natural world. Social factors examine how a company treats people, including employees and customers. Finally, governance factors consider aspects of a company’s operations, such as executive pay.

How ESG got here

A Labor Department ruling in 2020 curbed access to ESG investments in 401(k) plans by requiring retirement fund managers to base investment decisions solely on factors that would bring in the highest financial returns. This prohibited fund managers from considering other factors — such as ESG criteria. In addition, this meant ESG index funds, exchange-traded funds and mutual funds weren’t allowed to be considered for inclusion.

Since then, it has been a polarizing topic in a divided Congress. In November 2022, the Labor Department under Biden reversed the Trump-era ruling. In March, Congress responded by passing a bill nullifying the Biden administration’s ESG investing policy. Now, Biden has vetoed the predominantly Republican-backed measure.

“The rule reflects what successful marketplace investors already know — there is an extensive body of evidence that environmental, social, and governance factors can have material impacts on certain markets, industries, and companies,” the White House said in a released statement.

The issue is not everyone agrees.

“The Employee Retirement Income Security Act (ERISA) is supposed to protect retirement investment plans by requiring plan managers to be subject to fiduciary responsibilities,” said Rep. Greg Murphy, R-N.C., in a prepared statement.

Murphy, who introduced the bill calling for a ban on ESG investments, said the legislation aims to protect investors. 

“However, the Biden administration’s proposed changes to ERISA abandon fiduciary responsibility by allowing ‘woke’ ESG factors to dictate investment returns — putting Americans’ retirement savings at risk.”

What Biden’s veto means for consumers

Biden’s veto — if it stands — ensures that consumers will continue to be able to access ESG investments through their employer-sponsored plans, such as 401(k)s if they wish, though it is not required.

And because it is not required, some financial advisors say ESG investing shouldn’t be a partisan issue.

“Political attacks on ESG miss the point,” Michael Reynolds, a certified financial planner and owner of Elevation Financial in Westfield, Indiana, said in an email interview. “In addition to values, ESG is about investment results. ESG factors are meant to be part of a prudent investment process and align with the responsibilities of a fiduciary.”

Fund managers are beholden to a fiduciary duty, meaning they legally must choose investments in the best interest of their clients. Without Biden’s veto, “best” would have strictly meant “best-performing.”

And while “best-performing” is certainly a less squishy definition than “best” when it comes to investing, ESG investments propose that what’s “best” should factor in risks such as climate change in addition to financial returns.

“A report from the U.S. Commodity Futures Trading Commission stated that climate change presents a significant risk to our financial system and the sustainability of the U.S. economy,” Randell Leach, CEO of Beneficial State Bank in Portland, Oregon, said in an email interview. “While some lawmakers want to politicize any acknowledgment of the effects of climate change, the risks cannot be denied.”

Difficulties in evaluating ESG performance

Supporters say ESG investments have increased returns and decreased risks. ESG critics, on the other hand, say it pushes liberal values and costs investors more. 

There is evidence on both sides of the argument. It doesn’t help that ESG’s popularity increased during a global pandemic and a tech boom — factors that further complicate any evidence supporting either view.

Social issues such as the Black Lives Matter movement, the difficulties immunocompromised people face navigating public spaces, and the health risks faced by those in the health care and hospitality industries all came to the forefront in 2020. 

ESG investing had existed for years, but the public sphere had never been so primed to care about it.

Retail investing exploded during the pandemic and money flowed into ESG funds at an unprecedented rate: According to Morningstar data, money that flowed into sustainable open-end and exchange-traded funds available to U.S. investors reached $51.1 billion in 2020, more than doubling from 2019.

Biden also signed legislation that bolstered clean-energy technologies. After signing the Inflation Reduction Act in August 2022, clean energy stocks jumped significantly.

“The political attacks against ESG are designed to confuse the marketplace and slow adoption, much like climate denial,” Leach said. 

“ESG detractors are claiming that ESG investments are solely ideologically driven, rather than a consideration of risks and opportunities that have long been ignored.”

Leach also notes that most investors who integrate ESG criteria in their approaches will continue to do so.

“Smart investors are looking at worsening climate risks and growing public support for renewable energy, among other data, and know that there’s still a huge market for ESG investing,” Leach said.

Performance as the metric for inclusion

Studies and statistics show ESG funds perform better and worse than their traditional counterparts, but some investors might wonder: Is performance actually the issue?

Plenty of traditional funds perform worse than others. Plenty of funds with high fees are eligible for 401(k) plan consideration, despite there being cheaper options. Plenty of sectors have bad years or decades — but that doesn’t exclude them from 401(k) plans. 

For example, if oil performs worse than the market at large, does that mean investors shouldn’t have access to it?

“My stance is that the politicization of ESG is hurting the individual investor by limiting choice and going against what more and more Americans are asking for, which is investing options that align with their values,” said Reynolds.