Safeguarding Americans’ financial futures from climate change

This post is co-authored with Michael Panfil, Director of Climate Risk Strategies Project Manager at EDF.

Climate change presents immense risks for our society. These include, as is becoming increasingly apparent, the financial system. Now, the U.S. Department of Labor is taking a step to help safeguard one critical part of our economy and a cornerstone of many Americans’ financial futures – workers’ retirement savings.

The Labor Department has proposed a rule that would make clear that retirement plan managers can consider climate change when making 401(k) investment decisions. Risk management is bedrock to our financial system, and this proposal empowers 401(k) plan sponsors to incorporate the substantial and growing risks posed by climate change alongside other financial risks.

A substantial body of research highlights the financial risks stemming from climate change. The London School of Economics found that climate change could cause trillions of dollars in financial damage, far more severe than the 2008 financial crisis. The U.S. Fourth National Climate Assessment found climate change could stifle economic growth by 10% by 2100.  The U.S. Commodity Futures and Trading Commission released a report last year that found Earth’s rising temperatures, and resulting extreme weather, pose “a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy.” These findings were reaffirmed last week, with an Executive Order initiated risk and finance report by the White House making clear that “climate change poses serious and systemic risks to the U.S. economy and financial system.”

These climate threats present new financial risks to retirement savings. Mercer and the Center for International Law found that the average asset values of U.S. public pension portfolios could decline by 6% by 2050 due to climate risks. S&P Global has noted that roughly 60% of S&P 500 companies hold assets with elevated exposure to physical climate risks, which jeopardizes the long-term financial stability of Americans invested in passive index funds.

401(k) plans, and the hard-working Americans invested in them, are exposed to these vulnerabilities. Only 13% of 401(k) participants have access to funds that actively integrate climate risks and other environmental, social, and governance (ESG) factors. Less than 1% of 401(k) assets are invested in these funds.

The Labor Department’s proposed rule can help reverse this trend. By emphasizing that “ESG factors are no different than other ‘tradition’ material risk-return factors,” the rule endeavors to “eliminate unwarranted concerns about investing in climate change and ESG funds.” It would also allow ESG and climate-friendly funds to serve as “qualified default investments alternatives” – funds that employees automatically opt into upon enrolling in a 401(k) plan – which dominate the 401(k) investment landscape, accounting for roughly 80% of new participant contributions.

The proposed rule would also change the “tie-breaker” standard. For years, the Labor Department has offered instruction on what factors to consider if multiple investment options are indistinguishable or “tied.” This new proposal emphasizes that, so long as investment options are selected prudently, any factor – either economic or non-economic – can be used to break a tie. This provision would open the 401(k) market for greater ESG adoption to the benefit of American workers.

Additionally, the Labor Department’s proposal would provide fiduciaries with greater freedom to engage in proxy voting on behalf of 401(k) plan participants – a key component of climate risk management. Shareholder engagement and proxy voting are core to how investors mitigate portfolio-wide climate risk. Enabling fiduciaries to vote on shareholder proposals can help ensure that employees’ financial portfolios withstand the effects of climate change.

The new Labor Department proposal may seem highly technical and obscure, but it will help protect the retirement savings of hard-working Americans from a serious and intensifying financial risk. The changes the agency puts forward could mean the difference between an investment portfolio exposed to climate risks, or one protected from them. Americans’ financial futures will be safer if the Labor Department finalizes this proposal and makes these changes law.

This entry was posted in Economics. Bookmark the permalink. Both comments and trackbacks are currently closed.

One Comment

  1. Posted October 31, 2021 at 2:34 am | Permalink

    I have worked to together to make a positive impact on America’s economy, others who rely on our markets to secure their financial futures. To help market participants address issues related to sustainability and climate change.