SEC prepares to crack down on misleading ESG investing claims

The US securities regulator is set to crack down on overblown environmental, social and governance credentials in investment products, preparing standards for a sustainable fund industry that has exploded to nearly $3 billion.

Rules being drafted by the Securities and Exchange Commission would specify disclosures to be made by investment funds that have terms such as “ESG,” “sustainable” or “low-carbon” in their names. The rules should require disclosures about how ESG funds are marketed, how ESG is integrated into investing, and how those funds vote at company annual meetings, according to people familiar with SEC thinking.

Global sustainable fund assets totaled $2.77 billion at the end of the first quarter of 2022, up from $1 billion in 2019, according to Morningstar, a data provider. The broader category of ESG investing covers environmental and climate considerations, “impact” investing for social good as well as funds that weed out industries such as tobacco or firearms.

“There is currently a wide range of what asset managers might mean by certain terms and criteria they might use,” SEC Chairman Gary Gensler said in March. “It’s easy to tell if the milk is fat-free. Maybe it’s time to make it easier to determine if a fund is really what it claims to be.

The four-member SEC, which includes Gensler and two other Democratic appointees, is scheduled to vote Wednesday to release the draft rules for public comment.

The agency has already signaled a tougher stance on the matter. On Monday, it announced a $1.5 million legal settlement — its first related to ESG descriptions of funds — against BNY Mellon’s investment advisory division over allegations of errors and omissions in disclosure about ESG criteria of the mutual funds he managed. BNY Mellon said none of the sustainable funds it offered were targeted by the regulator and it had updated its fund documents.

“Greenwashing is a huge problem, and the SEC is right to deal with it,” said Jonathan Macey, a professor at Yale Law School, adding that the regulator’s enforcement action against BNY Mellon and its proposals on eco-friendly definitions “would have a significant impact on mutual fund communication around ESG”.

In the United States, 65 funds have been repackaged as ESG funds since the start of 2019, according to Morningstar. Funds that struggled to attract flows have changed names and prospectuses to ride the wave of sustainable investing, said Jon Hale, director of sustainability research for the Americas at Sustainalytics, a Morningstar company. .

“A lot of financial advisers are okay with recommending ESG investments if clients ask for them, but I’m not sure about their judgment,” Hale said. “Consumers are asking, ‘What is it, and is it genuine?'”

The SEC’s draft rules stem from an analysis of the ESG market carried out in April 2021. They are based on a “naming rule”, adopted in 2001, which requires funds to invest at least 80% of the assets of a way suggested by the name. For example, an equity fund cannot have more than 20% in cash or treasury bills.

Jill Fisch, professor of securities law at Penn Law, warned that “heavy rulemaking” in an “evolving” field such as ESG “could have a chilling effect on market innovation in this area. space”. Fund disclosures have already become more “expansive” in an area where there is no “market consensus around what constitutes an ESG fund”, she added.

“These are not standardized products. . . A rule that tries to standardize what constitutes an ESG fund is going to be a big step backwards for people who want to invest in this space,” Fisch said. “Standardization is not the same as clarity”.

The SEC has also proposed tougher guidelines on corporate climate disclosure, issuing long-awaited rules in March that would require public companies to disclose their direct greenhouse gas emissions and have them audited. by a third party. The agency did not respond to requests for comment.

The commission is also catching up with regulators in Europe. The EU’s sustainable finance taxonomy, which would establish a list of eco-friendly economic activities, is expected to be approved by the European Parliament in July.

The Investment Adviser Association, a trade group, has urged the SEC to leave some leeway in its ESG proposal for professionals’ fiduciary duties to clients. “We would be concerned if the SEC limited or required fiduciaries to consider all factors, including ESG,” said Gail Bernstein, IAA’s general counsel.

Jennifer Han, head of global regulatory affairs at the Managed Funds Association, whose members include hedge funds, said: “Any rule should help clarify ESG strategies for alternative asset managers and be calibrated to different investor needs. institutions and individuals. ”

The Investment Company Institute, whose members include mutual funds and exchange-traded funds, declined to comment.

Additional reporting by Andy Bounds in Brussels

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