The US SIF: The Forum for Sustainable and Responsible Investment has contributed to Envestnet the following commentary blog regarding the SEC’s recent proposed rulemaking related to environmental, social and governance (“ESG”) investing:
On May 25, 2022, the Securities and Exchange Commission (SEC) jumped headfirst into the debate about transparency and accountability in funds that consider ESG factors. The Commission provided two notices of proposed rulemaking “Investment Company Names” and “Environmental, Social and Governance Disclosures for Investment Advisers and Investment Companies”.
The SEC’s intent with these proposals was straightforward: reducing the opportunities for greenwashing, providing investors with accurate information on the ESG criteria used by funds and ensuring that funds say what they do and do what they say.
The Names Rule Proposal seeks to do the following:
Expand the number of funds falling under the Names Rule’s 80% standard to include funds whose name suggests the fund’s focus. This includes names that indicate a particular type of investment, investment in a particular industry, a particular country or geographic region, or particular characteristics such as “growth,” “value,” and ESG factors.
Bar funds that consider ESG factors where the consideration is “generally no more significant” in investment decision making than other factors from using ESG or similar terms in their names.
The ESG Fund/Advisor Disclosure Proposal seeks to do the following:
Create three categories for funds that consider ESG criteria with different levels of disclosure for each. These categories from least disclosure to most disclosure are Integration Funds, ESG-Focused Funds, and Impact Funds.
Integration Funds: A fund that “considers one or more ESG factors alongside other non-ESG factors” when making investment decisions, but the ESG factors are “generally no more significant than other factors.”
ESG-Focused Funds: A fund that focuses on one or more ESG factors, using them as a “significant or main consideration” when investing or in its engagement strategy. This includes any fund whose name or advertisements indicate that one or more ESG factors are used.
Impact Funds: A sub-category of ESG-Focused funds in which a fund seeks to “achieve a specific ESG impact” through its investment strategy.
If integration funds consider greenhouse gas (“GHG”) emissions in their investment strategy, then they must describe how they consider it and their internal methodology. ESG-Focused and Impact funds must report the carbon footprint and weighted carbon intensity of the portfolio company using Scope 1, 2, and 3 emissions.
Registered Investment Advisors: If a registered investment advisor considers any ESG factors in their investment strategies, then they will be required to disclose them in Form ADV and their brochure. They will have to disclose what category their fund fits within, the specific ESG factors they consider, what third-party ESG frameworks, if any, they use, and what specific strategies they use.
US SIF supports the SEC’s efforts to increase fund transparency and ensure fund managers and advisors accurately describe how ESG factors are utilized and that they actually follow the processes that they describe. But we believe that there are major changes that need to be made to each proposal before they actually do what the SEC set out to accomplish.
It is vital that in drafting the final version of these regulations, the SEC ensure that 1) information is disclosed in a useful manner; 2) asset managers and advisors are not incentivized to minimize sustainability or ESG criteria in their strategies; and 3) product innovation in sustainable investment continues.
To achieve these outcomes, US SIF offered the following recommendations to strengthen the fund and advisor disclosure proposal:
Remove the fund categories and require all funds that consider ESG factors to disclose the same information to investors.
Instead of only requiring one metric on the number of meetings held, require a qualitative explanation of shareholder engagement activities.
Require consistent GHG emissions metrics disclosures for funds that consider climate-related factors.
Eliminate the proposal’s provisions applicable to registered investment advisers.
Our recommendations to strengthen the Names Rule proposal include:
Clarify the definition of funds that may not use ESG or sustainability terms in the fund name.
Ensure flexibility for funds to come back into compliance upon departure from the 80% policy requirement.
The SEC received many responses to the public comment period that ended August 16, 2022. The Commission will now need to consider these responses to craft final regulations. We expect the regulations to be finalized in the first part of 2023. You can read our full comment letter on the proposed naming rule here and the proposed disclosure rule here.
We believe that it is vital for funds to say what they do and do what they say. These proposals could have a huge potential to shape our field. With important refinements to the final rules, we believe that the SEC will help to increase transparency and accountability for funds considering ESG, decreasing the opportunity for greenwashing and increasing the benefit to investors. It is fundamental for retail investors and advisors to know and trust where their money is going and how it is being invested.