SEC ESG Investor Protection Proposals

On May 25, 2022, the US Securities and Exchange Commission (SEC) voted 3-1 in favor of proposals that would “promote consistent, comparable, and reliable information for investors concerning funds’ and advisers’ incorporation of environmental, social, and governance (ESG) factors.” ESG assets under management (AUM) are expected to grow by at least 15% in the coming years, reaching $50T by 2025, and accounting for a third of all global AUM. With this growth, there has been increased concern from the investor community regarding the lack of a standardized nomenclature for ESG stocks, bonds, and funds, and whether the underlying assets in fact align with the ESG factors advertised. The most recent proposals, along with the proposed climate-related risk disclosure requirements published in March, are designed to increase the level of transparency into the ESG investment landscape.

What was Proposed?

The first proposal—ESG Strategy Disclosure for Funds and Advisors—seeks to standardize ESG disclosures and categorizations such that investors have an objective basis for comparison across funds. The proposed changes would apply to certain registered investment advisors, advisors exempt from registration, registered investment companies, and business development companies, the products of which fall into three broad groups: Integration Funds, ESG-Focused Funds, and Impact Funds:

  • Integration Funds would be required to describe how they consider ESG factors.
  • ESG-Focused Funds would be required to provide more comprehensive disclosures regarding their ESG strategy.
  • Impact Funds would be required to disclose the impact sought, how they will measure progress toward the impact sought (including key performance indicators used, and expected time horizon), and the relationship between the impact sought and financial returns.

The proposal would also require: 

  • Additional Disclosure Regarding Impacts and Proxy Voting or Engagements would require funds that use proxy voting to provide more information on their ESG strategy, metrics, and desired impact.
  • Greenhouse Gas (GHG) Emissions Reporting would require ESG-focused funds to disclose additional information regarding the GHG emissions associated with their investments.

The second proposal would expand the scope of the SEC’s existing “Names Rule,” which states that if a fund’s name suggests a focus on certain industries, geographies, or investment types, the fund must invest at least 80% of its holdings in such assets, to include fund names that suggest an ESG-related investment focus, such as those that contain “ESG,” “sustainable,” or “socially responsible.” As such, funds that do not weight ESG factors over other inputs would not be allowed to use ESG, or related terms, in their names moving forward.

What Does This Mean?

Under the SEC’s proposals, if you are an SEC registrant with funds marketed with ESG or a related term, such as “green” or “sustainable,” you would be required to enhance your disclosures, and the underlying governance, to include reporting on the funds’ ESG strategy, the factors considered in investment selection, and the metrics by which you are measuring impact. The rules would also require fund managers to collect, distill, and report on new information, such as waste generated in operations and upstream/downstream transportation.

There is a 60-day comment period during which the public can respond to the proposals. If passed, these proposals could lead to more enforcement actions by the SEC, a trend that is already underway, as evidenced by recent investigations into claims of greenwashing and of presenting false or misleading information about ESG strategy and investment decisions by financial institutions. Firms with an international reach may already face similar requirements from the European Union’s Sustainable Financial Disclosure Regulation. As governments continue to take steps to address ambiguities in ESG investing, financial institutions will need to apply a heightened level of rigor to how they define, and report on, their ESG strategy and decision-making.

 
Special thanks to Eleanor Gass, and Nirja Dave for co-authoring this article.

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