Here’s an update from the latest on ESG investing that falls under the category of “you probably heard about it, but just in case you missed it… ”
The U.S. Securities and Exchange Commission has proposed new rules that would require disclosures about investment strategies (mutual funds, ETFs, or other products) that claim to have an ESG focus or pursue “sustainable investing”. While the proposed rules may be amended before adoption, we think the concept and approach outlined by the SEC are thoughtful and appropriate, and see this as an important step to protect investors, which is the SEC’s job.
At its core, this is a “truth in advertising” policy. The SEC wants to promote “consistent, comparable, and reliable information for investors” about funds and advisors that say they incorporate environmental, social, and governance factors in their offerings. As the popularity of ESG investing continues to grow, fund managers and investment advisors want to capture a piece of the increasing number of investment dollars (and euros, pounds, yen, etc.) flowing into those strategies. While investors’ interest is genuine, unfortunately some percentage of funds that claim to “do” ESG in some form or fashion are not. They may have “ESG” or “sustainable” in the name of the fund, or may claim to integrate ESG factors into investment decisions but it has been difficult (in some cases next to impossible) to prove or disprove most of these claims.
Under the proposed rules, a Registered Fund (mutual funds and ETFs) that claims to consider ESG factors in its investment processes would be classified as either an “Integration Fund” or an “ESG-Focused Fund.” These are defined as follows:
- Integration Funds consider ESG factors in their investment decisions but those factors are “generally no more significant than other factors in the investment selection process,” and may not determine whether a particular security is included or excluded.
- ESG-Focused Funds use one or more ESG factors as “a significant or main consideration” in selecting investments or when engaging with investee companies. This includes funds that market themselves as having “an ESG focus”. If a Fund seeks to achieve a specific impact (e.g., improving water quality, supporting workforce diversity, etc.), it would also be classified an “Impact Fund” and would face additional requirements.
Registered investment advisers who incorporate ESG factors into any significant investment strategy or method of analysis would, among other things, have to add new disclosures to their ADV Part 2A brochures, including (1) a description of the ESG factor(s) considered and how they are incorporated into the adviser’s investment recommendations; (2) an explanation of whether and how the advisor implements ESG integration, ESG-focused strategies, or ESG impact strategies (see the definitions for Registered Funds described above); and (3) a description of any ESG criteria or methodology used in investment evaluation or selection, if applicable.
There is more, but those are the key points in our view. As we read it, the SEC is not telling Funds or advisors what they can or cannot do in terms of ESG investing; it is simply saying, “if you claim to be doing X, you need to demonstrate that you are, in fact, doing X.” While the devil is always in the details, this seems highly consistent with the EU’s Sustainable Financial Disclosure Regulations’ (SFDRs) definitions of Article 8 and Article 9 Funds. We think that’s a good thing.
Chairman Gensler has made it clear that he is skeptical that the hundreds of investment funds touting ESG credentials are delivering what they advertise. In releasing this proposal, he posted a video on Twitter in which he said, “If it’s easy to tell if milk is fat-free by just looking at the nutrition label, it might be time to make it easier to tell if green or sustainable funds are really what they say they are.”
Gensler also said “I think investors should be able to drill down to see what’s under the hood of these strategies. This gets to the heart of the SEC’s mission to protect investors, allowing them to allocate their capital efficiently and meet their needs.”
We agree. Disclosure is essential to investor confidence and the market for ESG investing has grown so quickly, disclosure requirements have not kept up and the U.S. trails behind many other developed countries in this regard. If you are a fund manager or investment advisor that is investigating how to meet these new requirements efficiently and affordably, OWL ESG has the data and tools you need. Please contact us to learn more.
