Impact investing has been gaining ever more acceptance in the past several years and the removal of two federal regulatory barriers last October is expected to further accelerate growth in the field.

In one of those actions, the Department of Labor issued a revision of 2008 guidance that was said to have had a chilling effect on investing that aims to achieve social ends as well as investment returns.

The 2008 guidance “gave cooties to impact investing,” said Secretary of Labor Thomas E. Perez, announcing the revision. The new guidance, that reverts to a rule issued in 1994, reaffirms that private pension plans subject to the Employment Retirement Income Security Act of 1974 (ERISA) can take social factors into account as long as returns are not compromised. “Today, we return to the sound principles … of 1994 … that fiduciaries may take social impact into account as ‘tie-breakers’ when investments are otherwise equal,” Perez said.

A month earlier, the IRS gave a boost to impact investing with an announcement that private foundations could use their endowments to make impact investments that made less than market-rate returns. While it has long been established that foundations may lose their favorable tax status if they profit from their grants and other charitable endeavors known as program-related investments, the IRS had never ruled whether foundations could profit from impact investments, made with endowment funds, and still retain favorable tax treatment. The IRS guidance made clear that they could.

“These two [actions] together mark the beginning of a rethinking of fiduciary duty more broadly,” says Jacob Gray, senior director of the Wharton Social Impact Initiative. “[This is] not just for ERISA pension funds and foundations, but also endowments of private universities, and of smaller foundations that look to the larger ones for guidance.”

The Department of Labor (DOL) change was the culmination of years of intense lobbying by labor unions, socially responsible investment firms, and advocacy groups. According to supporters of the guidance change announced in October, the 2008 guidance had a chilling effect on the practice of environmental, social and governance (ESG) investing that the 1994 guidance had clearly authorized. Under the 1994 guidance, pension funds were allowed to take ESG and other factors into account as long as that didn’t adversely impact financial returns. While the 2008 guidance also said that fiduciaries could consider ESG and other factors in making investments, it added the warning that if they did, they “will rarely be able to demonstrate compliance with ERISA” without rigorous written documentation. While some industry participants said that the guidance really didn’t change anything, others were confused if not deterred by it.

“It sent the message, ‘You better think twice,'” says Adam Kanzer, managing director of Domini Social Investments, a socially responsible investing money manager. In the 2015 guidance, the warning was eliminated and new wording was added conveying that there may be instances when, in fact, fiduciary duty required that a plan take into account ESG and other factors.

The IRS clarification was issued in response to appeals from foundations as to whether or not they could make investments related to their missions that also produced financial returns, and not lose their favorable tax treatment.

“It arms and equips leadership at the trustee and president level to make the case to the CIO and advisers that it’s not a breach of fiduciary duty.”–Brian Trelstad

Removing Barriers

The changes are expected to eliminate objections to impact investing that have discouraged some pension plans, foundations and others from looking into it. And, they provide additional momentum to the growth of impact investing — which is already accelerating. Impact investing assets in the U.S. rose 76% from $3.74 trillion to $6.57 trillion between 2012 and 2014, according to the U.S. Forum for Sustainable and Responsible Investment (USSIF), a nonprofit industry association. Impact investing is broadly defined here as any investment intended to produce both a financial return and social impact, and includes what is known as ESG investing (positive screening), SRI (exclusionary screening), as well as investing in companies whose purpose is to produce social impact.

“This removes a major barrier to getting involved in impact investing,” says Amit Bouri, CEO of the Global Impact Investing Network, also a nonprofit industry advocacy group. “To the extent that more pension funds [and other institutional investors] put funds into impact investing, that builds the overall credibility and legitimacy of this investment strategy,” and will attract more investors to the field.

“It arms and equips leadership at the trustee and president level to make the case to the CIO and advisers that it’s not a breach of fiduciary duty,” adds Brian Trelstad, a partner at Bridges Ventures, an impact investing firm.

While the rulings remove barriers, those involved in the field are not expecting billions of dollars of capital that have been penned up to suddenly flood into impact investments. Practitioners say there’s no way of knowing how many plans and foundations have foregone impact investing because of the DOL’s guidance and the lack of clarity from the IRS.

“You can’t prove a negative,” said Lisa Woll, CEO of the USSIF. But the Council on Foundations has received a flurry of inquiries about the significance of the IRS ruling and an unprecedented 400 participants dialed into a council-sponsored webinar on the subject shortly after its issuance, says John Cochrane, associate director for social innovation at the council.

As an indicator of the potential pent-up demand that exists among pension plans, Woll points to a survey USSIF conducted with Mercer in 2011 of public and other defined contribution retirement plans. When asked what steps might increase their offerings of SRI options, 74% of the 421 respondents said that “clearer legal or regulatory support for fiduciaries to engage in SRI” was either “very important” or “important.”

Despite this data, Woll and Cochrane expect a measured acceleration of impact investing rather than a surge as a result of the regulatory changes.

“I expect persistent, gradual takeoff,” says Woll. “Changes in retirement accounts are, by their nature, slow.”

The gradual acceleration is also likely because, with respect to the DOL guidance, many of those intent on doing impact investing have gone ahead and done it despite the questions raised by the 2008 guidance. They have done so on the assumption that nothing really changed in 2008 except the tone of the guidance, and that impact investing has been permissible, without interruption, since 1994.

“There are many individual investors who are attracted to [impact investing] but they don’t know what options exist. Intermediaries and advisors need to learn more about [it] as well.”–Amy O’Brien

TIAA-CREF, for example, has been offering ESG-vetted investments for at least 25 years to a client base that has been very interested in the approach, says Amy O’Brien, managing director and head of TIAA-CREF’s responsible investment team. This has included plans subject to ERISA and those that are not, but are likely to use ERISA as a standard for their investment practices. At the same time, investment consultants for pension plans had questions about the appropriateness of ESG investments after the issuance of the 2008 guidance, O’Brien notes. Like others, she says that while it’s impossible to say how many plans were deterred from ESG investing as a result of that guidance, the new guidance should remove those concerns.

The same is true on the foundation side. The F. B. Heron Foundation, for example, is one of several that have long done impact investing with endowment funds. And, in 2011, well before the IRS clarification, Heron committed to eventually doing so with 100% of its endowment.

“This doesn’t affect us,” says Dana Pancrazi, vice president, capital markets, at the Heron Foundation. “We made the decision with confidence.”

A Need for Basic Awareness

Still, for the most part, foundations do not invest their endowments for impact. As of the end of 2014, just 24% of private foundations did so, according to a survey of 142 foundations conducted by the Commonfund Institute.

For those not interested in impact investing, the revised guidance will lead to increased participation only as other obstacles fall, observers suggest. One of the most persistent obstacles remains the perception that one must make a tradeoff between impact and returns, despite the increasing availability of data indicating that impact investing can produce market rate or even better returns.

On the foundation side, the IRS guidance, “will not make those who are not interested in [impact investing] rethink it” so it will have no impact on other foundations, says Pancrazi of the Heron Foundation. “It simply removes one more veto point in agency change.”

Besides the persisting impression that there must be a tradeoff between return and impact, there is a lack of familiarity with impact investing in general and the regulatory changes specifically that impedes growth.

While barriers persist, the IRS and DOL rulings can only contribute to the muscular growth already underway in the industry.

“There’s still some basic awareness needed,” says O’Brien of TIAA-CREF. “There are many individual investors who are attracted to it but they don’t know what options exist. Intermediaries and advisors need to learn more about [it] as well.”

To raise awareness of the changes and to inform plan sponsors, trustees and investors how to act on them, the USSIF and the UN Principles for Responsible Investment, a United Nations initiative to promote responsible investing worldwide, are among those planning education campaigns in the next few months. The USSIF is putting out two fact sheets — one for plan sponsors, advisors and managers and one for retail investors — explaining the regulatory changes, their implications, the range of ESG, SRI, and impact investments available and how to go about investing in them. The UN PRI is also planning to put out educational pieces to explain the guidance and how investors can go about incorporating ESG into their investing.

On the foundation side, the regulatory barriers are pretty much gone, says Cochrane of the Council on Foundations.

But, one significant hurdle to increased impact investing is bringing together what have traditionally been entirely separate functions within foundations — decision-making about what grants a foundation will make and the managing of the foundation’s endowment. If foundations are going to begin making social impact investments with endowment funds, the two sides will have to work together, or merge, many practitioners say.

Impact investing requires that, “the money management and PRI side work together,” says Michael Etzel, a manager at The Bridgespan Group, a nonprofit advisor for philanthropists. “Traditionally, the investment management side was left out of the PRI discussion and the program team was left out of the money management discussion…. A single, informed discussion is needed to do impact investing.”

Bringing the two sides together could be a change that takes five years or more, according to Trelstad of Bridges Ventures. This is because the largest foundations want money managers with decades of experience with the most established firms and since those firms have only recently begun impact investing, it will be some time before there is a top-flight cohort of investment managers with impact investing experience for the foundations to draw on.

While barriers persist, the IRS and DOL rulings can only contribute to the muscular growth already underway in the industry. As indicators of the strength of the trend, industry participants cite major traditional investment managers, including BlackRock, Goldman Sachs, Bank of America, Morgan Stanley, and many others, introducing impact investing offerings; Morningstar announcing it will rate all mutual funds for their ESG performance; a growing emphasis on long term returns, and the millennial generation’s interest in ESG.

This momentum feeds on itself and makes a reversal of the trend, and in particular of the DOL guidance, improbable, observers say.

The 2008 guidance change was done out of the public eye and came as a surprise, say industry participants. The fact that it was reversed a mere seven years later could cause some fiduciaries to hesitate to act on the new guidance, fearing that it could change yet again.

But, the momentum toward wider acceptance of impact investing makes that unlikely, says Woll.

The setting of the Labor Secretary’s announcement of the revised guidance at the Alexander Hamilton U.S. Customs House in the heart of Wall Street with a representative of Morgan Stanley speaking sent the clear message that traditional financial institutions are involved, Woll observes.

“A new administration would face much more pushback immediately” if it tried to change the guidance again to be less favorable to ESG investing, she says.