With the rise in popularity of Environmental, Social, and Governance (ESG) investing, it’s no surprise that securities regulators are giving more thought to how fund managers and advisors use the term in their marketing and investment processes. With this in mind, we are keenly interested in two proposed SEC rules regarding ESG. Long story short, we appreciate the move towards greater regulation, but think one of the suggested rules falls short in a few key respects.
Proposed Rule Regarding Investment Company Names
One of the new proposed rules would expand the “Names Rule” to include funds that purport to concentrate on a particular investment strategy. For funds with ESG in their name, the effect of this rule would be that 80% of their investment policy would have to be focused on ESG investing. This would prevent funds from using the term simply to attract assets. Broadly speaking, we endorse this rule.
As we wrote in our comment letter to the SEC,
We support the Securities and Exchange (SEC) efforts to clarify fund names and minimize the use of misleading or deceptive fund names. A fund name communicates important information about the fund’s characteristics, investment style or theme. Thus, it is within the SEC’s core mission to protect investors by enhancing the Names Rule.
However, we believe the rule doesn’t go far enough. Our letter on the rule recommends that a fund using ESG in its name should have sustainability as a principal purpose, as opposed to merely one factor that it takes in account.
Proposed Rule Regarding ESG Disclosures for Funds
The second rule for which the SEC has sought public comment relates to required disclosures by funds who consider ESG factors in their investment process. As it stands, the proposal would separate ESG funds into three categories (Integration Funds, Focused Funds, and Impact Funds).
We have numerous concerns with the disclosure rule (see our letter here). First, fund companies themselves would be able to select the category by which they would be identified and regulated. This is a problem, because Integration Funds would only have to provide a few sentences to investors explaining their ESG process. But Focused Funds would have significantly greater obligations: They would be required to identify in the ESG Strategy Overview summary table the ESG strategies it follows, such as screening, reliance on third-party data and ratings, and use of an index, as well as provide brief descriptions of how ESG factors are incorporated and how they vote proxies and/or engage with companies.
Our worry is that funds will naturally choose to be considered in the Integration category, thereby freeing them from substantive disclosure requirements. The option of choosing the Integration category would thus disincentivize development of high-quality ESG funds by substantially increasing the regulatory burden for those funds, while continuing to allow lower quality funds to skate by with less oversight. Our recommendation to the SEC is that there should only be one category, and robust disclosure should be required from all ESG funds. Robust disclosure for all is the best way to tackle the pervasive issue of greenwashing in the investment industry.
Finally, while we are happy to see that the proposed rule mandates annual disclosure of greenhouse gas emissions related to a fund’s portfolio, we believe that solely looking at the “E” in ESG is a mistake. The SEC should broaden the rule to include metrics on important issues such as human rights and public and worker safety.
Change doesn’t happen overnight. So, on an optimistic note, even though we see room for improvement in these two proposed rules, we’re heartened to see regulators moving in the right direction.