On May 25th, 2022, the Securities and Exchange Commission (SEC) proposed a number of amendments to rules and reporting procedures for investment companies and registered investment advisors. The proposed amendments are designed to promote consistent, comparable and reliable information for investors concerning the incorporation of Environmental, Social and Governance (ESG) factors in funds and strategies. The SEC also proposed amendments to the “Names Rule” (Rule 35d-1) expanding the scope of the rule to include names that indicate ESG related investment strategies. The proposed amendments seek to categorize certain ESG strategies, and require investment advisors to provide specific disclosures in fund prospectuses and annual reports. Funds focused on ESG investments would also be required to disclose the greenhouse gas (GHG) emissions associated with any portfolio investments. These amendments follow the SEC’s announcement on March 21st, 2022, proposing climate-related disclosure rules for public companies, focusing specifically on “greenwashing” and similar misleading claims on the extent to which investments products are adhering to ESG parameters.  

“I am pleased to support this proposal because, if adopted, it would establish disclosure requirements for funds and advisors that market themselves as having as ESG focus,” said SEC Chair Gary Gensler.   

What this means   

The proposed amendments seek to identify and categorize different types of ESG strategies, and require investment funds and advisors to provide more specific disclosures in fund prospectuses, annual reports and advisory publications. The measures would also provide guidance on how different categories of ESG funds should market their names and investment practices;  

  • ESG Disclosure and Reporting – The proposal would require funds to consider ESG factors in their investment process and strategy, and would depend on how central ESG concerns are to individual funds. The SEC has proposed a framework to identify different types of ESG funds, and how their prospectus and disclosure processes would be required to report in their annual filings with the SEC:
    • Integration Funds – where ESG and non-ESG factors would be integrated in investment decisions, and fund advisors would be required to describe how ESG is incorporated into investment decisions 
    • ESG-Focused Funds – where ESG factors are a significant consideration, fund advisors would be required to provide detailed disclosures 
    • Impact Funds a subset of ESG-Focused Funds that seek a particular ESG impact, where fund advisors would be required to disclose progress on their objectives   
  • ESG Strategy Impacts on Proxy VotingCertain ESG-Focused Funds would be required to provide information about the impacts they expect to seek, and details on any proxy voting communications and results 
  • “Names Rule” AmendmentsThe proposal would require funds with ESG in their name to clearly define the term, and confirm that 80% of the assets in the fund adhered to that definition
  • Greenhouse Gas (GHG) Emissions Reporting – The proposal would require ESG-Focused Funds to disclose additional information regarding the GHG emissions associated with any investments, including the carbon footprint and carbon intensity of any portfolio.

The SEC is not alone in proposing new regulations for ESG procedures. In the European Union (EU), the Sustainable Finance Disclosure Regulation (SFDR) categorizes funds and regulates ESG investments through fund disclosure agreements. Similarly, in the UK, the Financial Stability Board (FSB) has created the Task Force on Climate Related Disclosures (TCFD) to set out a series of recommendations to establish a framework for businesses to manage climate related risks. Similar regulations are proposed in Canada and across APAC. While these focus on sustainability in particular, the SEC proposals cover all three ESG factors. Investment companies and registered investment advisors would need to consider how to approach these new requirements.   

Investment companies and registered investment advisors may need to invest capital and resources in order to assure compliance with any new regulations. Impacts and challenges across products and services, as well as data governance, strategy, financial planning, capital allocation, and investor suitability will need to be addressed.  

Conclusion

Global ESG funds received a record $649 billion in investments in 2021 up from $542 billion in 2020 according to data from financial services firm Refinitiv Lipper, and ESG funds now comprise approximately 10% of global fund assets. The proposed amendments impose new and standardized requirements for investment companies and registered investment advisors, and are designed to meet demand from investors seeking funds and investments that are focused on a range of environmental goals, allowing them to make those decisions in line with their ESG expectations.

While the proposed amendments impose new and standardized requirements for investment companies and registered investment advisors, the SEC already has the regulation to bring enforcement against investment advisors for “Greenwashing,” and will likely continue to do so.

“ESG encompasses a wide variety of investments and strategies. I think investors should be able to drill down to see what’s under the hood of these strategies,” SEC Chair Gary Gensler said. “This gets to the heart of the SEC’s mission to protect investors, allowing them to allocate their capital efficiently and meet their needs.”

The proposals will be published in the Federal Register, and will enter a 60 day comment period during which time investment companies, investors and other market participants can comment and suggest changes to the proposed rules.

Stay tuned for Blog #2 on Challenges Ahead.

References 

  1. SEC Proposes to Enhance Disclosures by Certain Investment Advisers and Investment Companies About ESG Investment Practices – SEC Proposes to Enhance Disclosures by Certain Investment Advisers and Investment Companies About ESG Investment Practices 
  2. SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors – SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors 
  3. SEC Unveils Rules to Prevent Misleading Claims by ESG Funds – SEC unveils rules to prevent misleading claims by ESG funds (cnbc.com) 
  4. SEC Takes First Step Toward Standardized ESG Disclosures for Funds and Investment Advisors – SEC Takes First Step Toward Standardized ESG Disclosures for Funds and Investment Advisers | HUB | K&L Gates (klgates.com) 
  5. Task Force on Climate Related Disclosures – TCFD- TCFD – Risilience 
  6. Launching a Global Standard for Measuring and Reporting Financed Emissions – Launching a Global Standard for Measuring and Reporting Financed Emissions | Guidehouse 

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