Along with ramping up enforcement, the SEC has proposed amendments that could affect funds with and without an ESG focus
Fund managers always need to be on top of changes in regulations from the Securities and Exchange Commission in order to ensure compliance. Recently, the SEC proposed a number of rule changes regarding what funds will have to disclose with regards to emissions and ESG policies.
Though not yet finalized, these proposed changes are part of a larger strategy to cut down on “Greenwashing.” Here’s a primer on what greenwashing is, what the SEC is doing about it, and how to avoid it.
What is Greenwashing?
Greenwashing refers to the exaggeration or misrepresentation of a company’s ESG credentials. This can include token environmental initiatives that a company boasts about but that are never actually put into place, as well as investment products sold as impact investments that make no attempt to actually achieve the social impact they claim.
The market for impact and ESG continues to grow as investors increasingly demand investment products that can provide returns while positively impacting communities and the environment. Increased social consciousness means investors care about the practices of the companies they work with and expect meaningful commitments to sustainability, diversity, and social responsibility.
Stating that your company has a plan to become carbon-neutral will only make you more attractive to the next generation of investors, and claiming your fund is ESG-focused is a great way to stand out. The problem is that many of these claims are hollow, and investors know it, which is why they’re often skeptical of ESG reports.
Required disclosures can provide investors with the information they need to select investments based on ESG criteria. However, as currently constructed, it can be difficult for investors to tell what is actually being said, which is why the SEC wants to improve these disclosures, and crack down on those who misstate their ESG accomplishments.
How the SEC is becoming more vigilant about greenwashing
In order to put a stop to the practice of greenwashing and restore investor confidence, the SEC must accomplish two things: 1) institute strict rules regarding what must be disclosed to investors and regulators, and 2) enforcement against those who violate investors’ trust. We’ll cover the first of these in a later section; as for the second, the SEC has ramped up efforts to take action against those who misrepresent their ESG initiatives.
The SEC is investigating DWS Group, the asset management arm of Deutsche Bank, over claims it made about its sustainable investing practices. The company’s offices were recently raided by German authorities, which led to the resignation of its CEO.
Another target of SEC investigation has been BNY Mellon Investment Adviser, Inc., which agreed to pay a $1.5 million penalty in order to settle charges that it made misstatements and omissions about the use of ESG considerations in making investment decisions for certain mutual funds.
The key here is that it’s not enough to merely say you use ESG criteria when making investment decisions – you have to actually prove it, and that requires hard data. DWS lacked quantifiable integration for many asset classes, and ESG considerations were not an integral part of the company’s decision-making, which conflicted with what it told investors.
At JTC, we’re at the forefront of data-based Impact and ESG reporting. We’ve pioneered methods for quantifying social impact and helping investors compare investments with different impact goals. JTC has also created the virtual Chief Sustainability Officer platform, which helps companies without a dedicated executive craft and execute necessary policies.
While the SEC is ramping up enforcement of its current rules, even more scrutiny is coming. The agency has launched a Climate and ESG Task Force with the goal of identifying ESG-related misconduct. The agency has also introduced several proposed rule changes that would greatly increase what companies are required to disclose to investors and to the government.
Proposed changes to SEC rules regarding ESG funds
In addition to going after companies that make false claims regarding ESG, the SEC is also attempting to make disclosures about investment practices more helpful for investors. Proposed amendments would institute several requirements, including:
- Requiring funds and advisers to provide more specific disclosures in fund prospectuses, annual reports, and adviser brochures based on the ESG strategies they pursue
- Funds focused on environmental considerations must disclose greenhouse gas emissions associated with their investments
- Funds aiming to achieve a specific impact must describe this impact and summarize their progress in working toward those goals
- Funds and advisers would also have to disclose certain ESG information on government reporting forms to inform the Commission’s future decisions
For investors, this would mean more information to help them determine if a fund’s ESG claims are legitimate. For ESG funds, it would mean a greater regulatory burden and a greater expenditure of resources on collecting and reporting on this data. It also means that in order to stand out, impact funds will have to go the extra mile to prove they’re really walking the walk on ESG.
In addition, amendments have been proposed regarding funds that use ESG-related terms in their names. These amendments would expand “the current requirement for certain funds to adopt a policy to invest at least 80 percent of their assets in accordance with the investment focus the fund’s name suggests” and would provide new enhanced disclosure and reporting requirements. The goal is to eliminate “materially deceptive and misleading use of ESG terminology” to ensure investors aren’t duped by funds that don’t incorporate ESG in their decision-making but attempt to look as though they do.
While these proposed rule changes would affect funds that promote their ESG components, there are further proposals that will affect the entire industry and how it reports on the effects of climate change.
The SEC’s proposed rules on climate-related disclosures
On March 21st, the SEC proposed a set of rules that would require companies to make broad disclosures about their climate-related ESG policies, risk-management processes, and how climate risks are likely to impact their businesses. The proposal would also require reporting on both direct and indirect greenhouse gas emissions, as well as emissions from upstream or downstream activities in the value chain, if material.
The language has not been finalized, but many in the industry are concerned both about the wording of some provisions and about how difficult compliance will be. Those without comprehensive ESG policies, data, and reporting will potentially need to make big changes to meet these requirements.
To help sort through the rhetoric and better understand these proposals, JTC hosted a webinar featuring a panel of industry experts covering important topics and answering questions submitted by attendees. Titled, “The SEC and ESG: What Happens Next,” the webinar is available to watch for free online. This is a perfect opportunity to learn about the future of ESG from some of the best minds in the industry.
