The SEC is preparing to crack down on misleading ESG investment claims

The US Securities and Exchange Commission is ready to crack down on excessive environmental, social and governance credentials in investment products, and prepare standards for a sustainable fund industry that has boomed to nearly $ 3 billion.

Rules drawn up by the Securities and Exchange Commission will specify disclosures to be made by investment funds that have terms such as “ESG”, “sustainable” or “low carbon” in the name. The rules are expected to require information on how ESG funds are marketed, how ESG is incorporated into investment and how these funds vote at companies̵[ads1]7; annual meetings, according to people familiar with the SEC’s thinking.

Global sustainable fund assets amounted to $ 2.77 million at the end of the first quarter of 2022, up from $ 1 billion in 2019, according to Morningstar, a data provider. The broader ESG investment category covers environmental and climate considerations, “impact” investments for the social good, as well as funds that filter out industries such as tobacco or firearms.

“There is currently a wide range of what asset managers can mean by certain terms and what criteria they can use,” said Gary Gensler, SEC chief, in March. “It’s easy to tell if milk is fat-free. It may be time to make it easier to tell if a fund really is what they say it is.”

The four-member SEC, which includes Gensler and two other Democratic nominees, is scheduled to vote on Wednesday to release the draft rules for public comment.

The agency has already signaled a tougher stance on the matter. On Monday, it announced a $ 1.5 million legal settlement – the first related to the funds’ ESG descriptions – against BNY Mellon’s investment advisory department due to allegations of misinformation and omission of information on ESG criteria for mutual fund managers. BNY Mellon said that none of the sustainable funds they offered were targeted by the regulator, and that they had updated the fund material.

“Greenwashing is a big problem, and the SEC has the right to deal with it,” said Jonathan Macey, a professor at Yale Law School, adding that the regulator’s enforcement action against BNY Mellon and its proposals for environmentally friendly definitions would “have a significant impact on mutual funds.” revelations about ESG ”.

In the US, 65 funds have been converted to ESG funds since the beginning of 2019, according to Morningstar. Funds that struggled to attract inflows changed names and prospects to keep up with the sustainable investment wave, said Jon Hale, director of sustainability research for America at Sustainalytics, a Morningstar company.

“Many financial advisors are OK with recommending ESG investments if clients ask for them, but I’m not sure how picky they are,” Hale said. “Consumers are wondering, ‘What is it, and is it authentic?'”

The draft SEC rules stem from an analysis of the ESG market conducted in April 2021. They are based on a “name rule”, adopted in 2001, which requires funds to invest at least 80 percent of their assets in a way that the name suggests. An equity fund, for example, can have no more than 20 per cent in cash or government bonds.

Jill Fisch, professor of securities law at Penn Law, warned that “heavy-handed work” in a “developing” field such as ESG “could have a cooling effect on market innovation in this area”. The funds’ revelations have already become more “expansive” in an area where there is no “market consensus on what constitutes an ESG fund”, she added.

“These are not standardized products… A rule that seeks to standardize what constitutes an ESG fund will be a big step back for people who want to invest in this area,” Fisch said. “Standardization is not the same as clarity. “.

The SEC has also proposed stricter guidelines for disclosures of corporate climate, and in March it released long-awaited rules that would force public companies to disclose their direct greenhouse gas emissions and have them verified by a third party. The agency did not respond to requests for comment.

The Commission is also catching up with regulators in Europe. The EU’s taxonomy for sustainable finance, which will establish a list of environmentally friendly economic activities, is expected to be approved by the European Parliament in July.

The Investment Adviser Association, an industry group, urged the SEC to give scope in its ESG proposal for professionals’ duty of trust towards clients. “We would be concerned if the SEC either restricts or instructs trustees to consider any factors, including ESG,” said Gail Bernstein, IAA’s attorney general.

Jennifer Han, Head of Global Regulatory Affairs at the Managed Funds Association, whose members include hedge funds, said: “Every rule should help clarify alternative asset managers who engage in ESG strategies and be calibrated to the different needs of institutional and private investors. ”

The Investment Company Institute, whose members include mutual funds and exchange-traded funds, declined to comment.

Further reporting from Andy Bounds in Brussels