The SEC came out last week with its most aggressive plan yet to stamp out greenwashing in the financial industry. Specifically, the agency is targeting funds that have been raking in billions of dollars by marketing themselves as dutiful stewards of environmental, social and governance principles.
Wall Street’s reaction? In a nutshell, how can the government expect investment firms to know what the letters “ESG” actually mean (despite selling products labeled as such) when regulators haven’t defined them?
The SEC has proposed two rules: The first would expand an existing regulation to ensure funds labeled ESG invest at least 80% of their assets in a way that truly lines up with that strategy. The second would require additional disclosures in annual reports and marketing materials that show how a fund or financial advisor takes ESG into consideration when investing, and also calls for funds to report their greenhouse gas emissions.
It’s that second rule that irks industry lawyers like Marc Elovitz, an advisor to private fund managers and chair of the regulatory and compliance group at Schulte Roth & Zabel. “It’s an extremely overbroad proposal,” he argued.
The Investment Company Institute (the most-influential of the investment industry’s lobbying groups in Washington) has already chimed in, claiming the emissions part of the rule is “unworkable.” That’s because some of that information, according to the lobby, almost certainly isn’t publicly available.
The greenhouse gases requirement would also pose problems for some environment-focused funds, added lawyer Michael McGrath, a partner at K&L Gates who represents asset management and investment funds.
“It presumes that the only way an environmentally-conscious fund would operate is as a fund focused on climate change,” he said.
Under the SEC proposal, funds that focus on water issues or wildlife habitation, for example, would have to either expressly state they don’t take carbon emissions into account at all, or devote significant efforts to quantify and report on how they address greenhouse gas emissions, rather than their other goals, according to McGrath.
Lawyers including Elovitz are more concerned about what they consider vague demands for more disclosure. “In effect, the SEC is treating all funds as ESG funds,” Elovitz said.”
While Wall Street’s lawyers and lobbyists attack the SEC proposals, analysts at BloombergNEF have provided a breakdown of what the proposed 362-page rule entitled “Enhanced Disclosures by Certain Investment Advisers About ESG Investment Practices” would mean for funds and their advisors:
- So-called integration funds would be required to show how ESG factors are incorporated in their investment process.
- ESG-focused funds would need to provide standardized data to disclose details about their ESG strategy. Some of the funds also would have to publish information in annual reports.
- Impact funds would need to disclose the progress they’ve made in meeting their targets in annual reports.
In addition to reporting emissions-related data, ESG-focused funds — where proxy voting or engagement is a part of their main ESG strategy — would have to disclose information about their proxy-voting history on ESG issues, as well as details about their ESG-related engagement meetings with companies.
The proposals are aimed at addressing the recent growth of the ESG fund industry, said Mallory Rutigliano, sustainable finance associate at BNEF in New York. “As with any nascent trend, it’s ripe for misrepresentation, conscious or unconscious opportunism or even blatant ‘greenwashing.’ The focus is often on the environmental side of ESG, but the same is true for the ‘S’ and ‘G’.”
The regulations would help investors understand what a fund endeavors to accomplish with its ESG claims, how meaningful an ESG title is and how to compare funds on a more apples-to-apples basis, she said.
In summing up the initiative, SEC Chairman Gary Gensler said last week that it’s really just all about “truth in advertising.”
The SEC will take public comment on the proposals for as long as 60 days, and may revise them before holding a second vote to finalize the regulations.
Rutigliano agrees with the industry lawyers that the proposals “don’t actually attempt to define ESG under the view of the SEC.” Elovitz warns that the new rulemaking “is setting up as a real challenge for the asset-management industry.”