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New SEC proposal calls for ESG disclosures

Advisers would have to describe their use of ESG factors, their strategies, methods of analysis and how they voted relevant proxies

As investor interest in ESG soars across the globe, the SEC has moved toward adopting a rule that would mandate advisers and fund managers make new disclosures so as to counter so-called ‘greenwashing’ – funds exaggerating their sustainable offerings to lure in all of that cash.

In a split, three to one vote, commissioners on 25 May approved a new proposed rule that would mandate new Form ADV brochure disclosures and other filings – all designed to clearly inform investors what they’d really get by way of their ESG investments.

The 362-page proposal, which would give you 60 days to comment after it appears in the Federal Register, would establish standardized disclosures to ensure registered funds aren’t “appearing to be something that they’re not”, in the words of SEC staffer Jessica Wachter.

Disclosure impact widespread

The proposal would impact investment advisers, including some that are exempt from registration, mutual funds, ETFs and BDCs. Index funds filing Form N-CEN also would face new disclosures. Besides Form ADV, Part 1 and the Form ADV brochure, the proposal would call on additional disclosures in registration statements, annual reports, fund prospectuses and other SEC filings – from Form N-1A to Form N-CSR.

Advisers would have to describe their use of ESG factors, their strategies, methods of analysis and how they voted relevant proxies. The amount of disclosure would depend on the extent of ESG investing by a fund. Three categories would be created: 1. Integration funds (in which ESG plays a smaller part) 2. ESG-focused funds (they rely on one or more ESG factors) and 3. Impact funds (designed to achieve a certain ESG goal).

ESG interest surging

Global assets invested in ESG securities hit $2.7 trillion last year, with U.S. assets making up $357 billion of this amount, said Commissioner Allison Herren Lee. As a testament to investor interest, she added that the US portion surged 51% in the last year. Given this rising interest, the need increases for “consistent, comparable and reliable information”, she added, in supporting the proposal.

Commissioner Caroline Crenshaw noted some funds use terms like “sustainable” or “green” more as marketing tools rather than investment philosophies. She added that the Commission has long required registrants to disclose material information to investors and the proposal does just this.

The lone Commissioner dissenter, Republican Hester Peirce, said the proposal “misses the mark”, would provide little benefit to investors, and would make enforcement difficult because it fails to define ESG. “‘I’ll know it when I see it’ is not currently recognized in administrative law,” she said.

‘To the point of parody’

The proposal is “proscriptive almost to the point of parody” and the one-year compliance timetable after a final rule “is laughingly short”, continued Peirce. The proposal’s mandate that compliance P&Ps must insist that meeting minutes where ESG is discussed are documented would amount to “micromanagement of asset management”, she said.

A more palatable alternative would be to tackle “greenwashing” through Enforcement, Peirce said.

Indeed, the proposal comes only two days after the Commission fined an adviser $1.5 million over ESG-related disclosures, and one month after the SEC sued a Brazilian firm that operated a dam that collapsed in 2019, killing 270 people, alleging the firm misled and harmed investors through false ESG disclosures.

“I think investors should be able to drill down to see what’s under the hood of these funds. This gets to the heart of the SEC’s mission to protect investors, allowing them to allocate their capital efficiently and meet their needs,” said Chairman Gary Gensler.

Brochure example

An example of a Form ADV brochure change within the proposal rule instructs an adviser that uses “criteria or a methodology for evaluating, selecting, or excluding investments in your significant investment strategy or method of analysis based on the consideration of ESG factors, [to] describe that criterion and/or methodology and how you use it for each applicable significant investment strategy or method of analysis.”