The SEC today took a step to clamp down on greenwashing, proposing two major rule changes — one for investment product names and another for ESG disclosures made by advisers and investment companies.
In two party-line votes with a Democratic majority of 3-to-1, the SEC commissioners moved forward with the proposed changes to existing regulations, putting the modifications out for 60-day comment periods.
Terminology
The first proposal is aimed at labeling for investment products under the 1940 Act. It would update a fund naming rule that was enacted in 2001 and hasn’t been revised since then to account for increased use of ESG and thematic investing.
Significantly, the Securities and Exchange Commission aims to stop fund providers from labeling products as ESG unless their investment process relies on ESG more so than other factors. A so-called “integration fund” that uses ESG alongside other factors “but not more centrally” than the other factors “would not be permitted to use ESG or similar terminology in its name,” the agency noted in a factsheet for the proposal, noting that doing so could be misleading or materially deceptive.
“As the saying goes, you should mean what you say and say what you mean,” SEC commissioner Caroline Crenshaw said in her remarks at the public hearing. “A fund’s name is often the first piece of fund information investors see. And while investors should go beyond the name itself and look at the fund’s underlying disclosures, a fund’s name can have significant impact on their investment decisions.”
Crenshaw made the comparison to going to an ice cream truck and having expectations about what one would receive when ordering a chocolate cone — that it would be cold, sweet and brown, even if some of the ingredients differed from other ice cream recipes.
Similarly, she noted, “I suspect that investors who invest in a dog and cat fund are not expecting to be investing in guinea pigs and gerbils.”
The SEC is proposing to make certain investment criteria subject to the 80% rule of the naming regulation, which means that four out of five investments in a product must align with the strategy implied by the product’s name. It would make names such as ESG, value and growth subject to that rule, though it would also allow funds to temporarily deviate from the 80% holdings limit in response to market conditions and in other limited cases.
However, Andy Behar, CEO of As You Sow said:“It didn’t go far enough.” A study published earlier this year by As You Sow found that 60 out of 94 funds labeled as ESG products lacked ESG conviction, with many products containing fossil-fuel investments.
He added: “It allows for this giant loophole where you can have a fossil fuel-free fund that is full of oil and gas.”
The proposed flexibility in deviating from the 80% rule would be helpful for fund providers, said Jennifer Klass, co-chair of the financial regulation and enforcement practice at Baker McKenzie.
The proposal also gives fund providers much to think about if they are repackaging funds as ESG products without substantially changing their investment philosophies.
“A lot of asset managers have integrated ESG factors into their investment process,” Klass said. “The point that’s made in both [SEC] releases is that if you really have integrated ESG into your process … firms have to be careful in how they name their products and how they are marketing their products.”
The naming rule proposal would also require “enhanced” disclosure requirements and would prohibit unlisted closed-end funds from deviating from the 80% limit without a shareholder vote.
The proposed rule changes are separate from a regulation the SEC is working to finalize around ESG and climate risk disclosures for public securities issuers.
Fund disclosures
The second proposal the SEC made today, ESG Disclosures for Investment Advisers and Investment Companies, seeks to prevent greenwashing in the strategies employed by those groups.
For fund companies, the SEC made a distinction between different levels of ESG use, outlining “layered” disclosure requirements. “Integration funds,” for example, would face the lowest disclosure requirements, while “ESG-focused funds,” would require detailed disclosure and a standardized ESG strategy review table. At the higher end of requirements are impact funds, which would need “generally similar disclosures in their brochures with respect to their consideration of ESG factors in the significant investment strategies or methods of analysis they pursue and report certain ESG information in their annual filings with the Commission.”
ESG-focused funds would have to provide more information about proxy voting and company engagements. Funds in that group that have an environmental focus would have to make greenhouse gas emissions disclosures, such as the weighted average carbon intensity of the portfolio. That, the SEC noted, would help environmentally conscious investors more easily compare products.
“The role of ESG issues in investing has undeniably changed over time,” Crenshaw said. “The products and services offered are as diverse as the ESG nomenclature.” Words like “sustainable” and “green” are often used as marketing tools, but play only a minimal role in some products’ investment processes, she noted.
“Clear and standardized disclosures allow investors to compare products and accurately price risk and opportunity with ESG practices,” she said. “Investors have a right to know what they are investing in.”
The lone Republican commissioner, Hester Peirce, voted against both proposals. Greenwashing is a legitimate concern, but the SEC already has a means of addressing it, Peirce said in her remarks. She cited the SEC’s action this week against BNY Mellon as evidence of that.
“We can enforce the laws and rules that already apply. A new rule that addresses greenwashing shouldn’t be a priority,” Peirce said of the naming rule proposal.
Further, adherence to the 80% rule “will rely on subjective judgments,” and could encourage investment providers to have more homogeneity in their products, to the detriment of investors, she said.
Ethan Powell, CEO of Impact Shares, acknowledged the need for more clarity around product naming, but he noted the industry is more likely to move forward in response to market forces than regulation.
“ESG in the longer term will not be a separate investment discipline,” Powell said.
The SEC’s proposals “might help to alleviate some of that [greenwashing] and scare the hell out of some asset managers,” he said. “The longer-term solution is market-based, and it will require the financial services industry to change its perspective to realize and to be more intentional around the social and environmental implications of capital.”
