The SEC’s Imperfect Solution to an Important Issue

In May 2022, the US Securities and Exchange Commission (SEC) proposed a rule that would require enhanced disclosures on environmental, social, and governance (ESG) investment practices. A second rule aims to better ensure that fund names reflect their assets and approach, with a particular focus on those purporting to focus on ESG or sustainability.

We commend the SEC’s desire to better define the nature and scope of funds and strategies that incorporate ESG or sustainability-related factors into their investment approach. There is certainly a need for greater clarity, especially given considerable investor interest and the recent proliferation of different approaches to the use of ESG or sustainability-related criteria. We also share the Commission’s concerns about ‘greenwashing’.

However, we do not believe the proposed rules are well-designed or entirely necessary to achieve their goals. In summary:

• We are concerned that in parts of the proposed rule, ESG or sustainability-focused funds are being singled out for additional scrutiny, definition and disclosure without an evidence-based rationale for doing so. In some cases, reporting is already sufficient for investor needs: for instance, with respect to proxy voting and proxy voting guidelines.

• Proposed classifications for different types of ESG or sustainability-focused funds will raise more questions than they answer, do not reflect how investment processes or funds are managed in the real world, and are not clearly delineated. We would advise against creating unrealistic categories or definitions that arguably do not provide additional insights to help investors.   
• Proposed mandatory reporting of greenhouse gas (GHG) emissions for any fund that “considers environmental factors” may be applied too broadly. GHG emissions are a very important measure of environmental impact, but they are less relevant to funds focused on environmental issues other than climate change, such as natural resources and biodiversity. This disclosure is appropriate for funds that consider climate change, but not necessarily for all funds that incorporate environmental concerns.
• The ‘names’ rule proposals appear broad enough to permit almost any approach to the incorporation of ESG or sustainability-related factors to classify their funds as such. Ambiguity here could ultimately undermine efforts to clampdown on ‘greenwashing’.