Just as regulators – in the aftermath of the 2008 crisis – clamped down on product misselling – whereby exotic funds and dicey financial instruments were inappropriately marketed to retail investors – the US SEC (Securities and Exchange Commission) is now looking to make an example of managers who they believe are guilty of “greenwashing”. This refers to misleading investors by overstating a focus on ESG (environmental, social, governance) factors, or sustainability impacts.
This nefarious practice has been allowed to proliferate due to the lack of joined-up regulation on ESG, the sheer volume of competing industry standards, and significant differences of opinion around the meaning and measurement of “ESG”.
So what is the SEC proposing?
The SEC is recommending that funds and advisers provide more specific disclosures about their ESG strategies in prospectuses, annual reports and adviser brochures. In the case of managers who say they are looking to make an environmental impact, they will be required to disclose the greenhouse gas emissions associated with their underlying portfolio investments.
The SEC continues that funds claiming to achieve a specific ESG impact could be required to describe the impacts in question and provide a summary outlining their progress in terms of meeting their ESG targets.
Other rules are also being tightened up. Existing SEC requirements stipulate that if a fund’s name implies it is investing in a particular industry, geography or investment types, then at least 80% of its portfolio must be made up of those assets. The SEC is now extending this to include ESG. This follows mounting concerns that a minority of managers are giving their funds ESG names or labels, but are running strategies which do not correlate.
Elsewhere, funds that use proxy voting could be required by the SEC to disclose information regarding their voting of proxies on particular ESG-related voting matters and information concerning their ESG engagement meetings.
The SEC’s uncompromising stance on ESG comes not long after it fined the investment advisory arm of BNY Mellon $1.5 million following misstatements and omissions about its ESG approach to managing funds. The SEC said claims made by BNY Mellon Investment Advisor that it had embedded ESG quality reviews into all of its funds turned out not to be the case.
Given that the SEC has repeatedly warned the industry that it would target greenwashing, the fine should not come as a surprise. As such, managers are bracing themselves for further ESG scrutiny – and potential sanctions – from the SEC.
The US’ approach towards ESG is largely being welcomed by the funds’ industry, who have been asking for greater clarity on the issue for a long time.
If investors are unable to benchmark managers on ESG – or believe they are being mis-sold products masquerading as ESG funds – then the appetite for ESG investing will inevitably flounder. Therefore, it is essential regulators take a tough line on greenwashing if confidence in the ESG market is to be retained.
It is very probable that other regulators will follow the US’ lead as they look to root out greenwashing.