On May 25, 2022, the US Securities and Exchange Commission (the SEC or the Commission) proposed rules that would require registered and exempt investment advisers (Advisers) as well as registered investment companies (Registered Funds) to provide standardized environmental, social, and governance (ESG) disclosures to their investors and the Commission (referred to herein as the ESG disclosures proposal). The SEC also proposed amendments to Rule 35d-1, which governs naming conventions for Registered Funds.
These proposed rules aim to enhance ESG disclosure by requiring additional specific disclosure requirements regarding ESG strategies in fund prospectuses, annual reports, and adviser brochures. They also propose to implement a layered, tabular disclosure approach for ESG funds to enable investors to compare ESG funds at a glance, as well as to require certain environmentally focused funds to disclose the greenhouse gas emissions associated with their portfolio investments. The objective of the proposed ESG strategy disclosure framework is to help investors determine whether a fund’s or adviser’s ESG marketing statements are translated into concrete and specific measures to address ESG goals and portfolio allocation. Additionally, the proposed disclosure rules will enable investors to make more informed decisions as they compare various ESG investments. The information required under the proposed rules on ESG investment strategies and disclosures should also be readily available to investment funds and advisers who consider ESG factors in their investment process, and thus is not expected to impose a heavy compliance burden. If adopted, the proposed ESG disclosure rules will mitigate the current risks related to voluntary disclosures—including greenwashing and lack of consistent, comparable, and reliable ESG data—which will boast investors’ confidence in ESG investing.
Over the years, there has been a tremendous growth in ESG investing. This is largely attributed to increasing public concern about and awareness of climate change, social inequities, and corporate accountability. According to Morningstar’s 2022 “U.S. Sustainable Funds Landscape Report,” there were 534 sustainable funds available to US investors in 2021, an increase of 36% from 2020. The money newly allocated to exchange-traded ESG investment funds also increased in 2021 according to Bloomberg, to $120 billion, which more than doubled the $51 billion invested in 2020. With this increasing demand, asset managers have continued to create and market ESG products.
Despite explosive growth, ESG investing in its current form has faced some criticism, including from politicians and regulatory entities. Some politicians have called ESG investing a “scam,” and others have expressed dissatisfaction with the ESG rating and evaluation process. Accurately marketing ESG funds is more feasible when companies in fund portfolios make relevant ESG disclosures, but when the US Government Accountability Office conducted a review of ESG disclosures and investment practices for public companies in 2020, it discovered that while public companies generally disclosed information about many ESG topics, those disclosures lacked details and consistency, potentially limiting their usefulness to investors. Additionally, the inconsistency of the voluntary ESG disclosure and reporting framework has increased investor skepticism toward ESG investments. The 2021 Edelman Trust Barometer on U.S institutional investors highlighted that 86% of US investors question the accuracy of ESG disclosures, noting that companies frequently overstate or exaggerate their ESG progress. 53% of investors doubt the accuracy of information on progress made on companies’ diversity and inclusion goals, and 52% doubt disclosures on effective management of climate risk. All this is attributed to lack of a common disclosure framework tailored to ESG investing, which has made it difficult for investors to understand the investment policies associated with specific ESG strategies to inform their investment decisions.
With these adverse trends, the implementation of the proposed ESG strategy disclosure rules will be a step forward to create a consistent standard for ESG disclosures, which will boost investors’ confidence in ESG investment and enhance sustainable development of the US economy.
In recent years, both the federal government and the private sector have taken initiatives to address ESG risks relating to climate change, social injustice, and corporate accountability. The federal government has enacted federal tax credit programs and issued executive orders on climate-related financial risks, protection of public health, and advancing equity and racial justice. Legislation such as the Fossil Free Finance Act has also been proposed. Private sector interest in ESG investing has also greatly increased. For instance, in 2021, more than $600 billion went into ESG-focused funds worldwide according to Refinitiv Lipper data, and a record $105 billion in private investments were made into clean energy assets, adding an unprecedented amount of renewable power capacity.