Caught in the Crossfire

US fund managers are caught between a fierce anti-ESG campaign by Republicans and mounting efforts to curb greenwashing, explains John Kostyack, Adviser to Sierra Club’s Fossil-Free Finance campaign.

The Securities and Exchange Commission (SEC) has gone to great lengths in recent years to tackle the issue of rogue US fund managers making dubious claims on their sustainability commitments.

Yet, there is still much room for progress.

Some recent examples included the fund Names Rule – an amendment to the Investment Company Act aiming to modernise names-related requirements in light of developments in the fund industry over the past two decades. Finalised in September last year, the new rule made it compulsory for registered investment firms with a name that suggests a specific investment focus to dedicate at least 80% of the value of their assets to those investments.

Although the final version was broadly similar to the original proposal, a notable difference stood out: the removal of a clause whereby ESG terminology in a fund’s name would automatically be considered materially deceptive or misleading, if ESG factors were equal to but not greater than other investment factors in the fund’s strategy.

That omission was heavily criticised by industry pundits, and has been consistently brought to light by the likes of Sierra Club – a US environmental non-profit organisation spearheading the Fossil-Free Finance campaign, which pushes major Wall Street companies to stop financing fossil fuel expansion and help accelerate the transition to a clean economy.

“The SEC left one aspect of the Names Rule for another day – which was the specifics around ESG marketing,” said John Kostyack, Adviser to the Fossil-Free Finance campaign. “Buried in the fine print of that rollout was the fact that they didn’t decide one way or the other about this, and were going to leave it until the next rulemaking.”

The issue, however, is that there are limited signs of the SEC having made this a priority. ESG was even dropped altogether from the regulator’s examination priorities for 2024, to the surprise of many. The agency’s much-anticipated rules to standardise issuers’ climate-related disclosures for investors are also still pending – despite nearly a year’s delay.

“Some fund advisors and managers would say they need the SEC’s final rule for issuers before they can disclose substantial information about portfolio companies, but we’re not buying that,” said Kostyack. “There is a lot of information sitting in their files that they should be sharing with customers, which is what has spurred us to work on this. This has its own merit for moving forward.”

Making no excuses

By “this”, Kostyack means the ESG Disclosure Rule, first laid out by the SEC in 2022. Proposing to enhance disclosures by certain investment advisers and companies on their ESG investment practices, the new rule aims to rein in greenwashing risk among asset managers.

The rule is aimed at any fund manager claiming that ESG risks are a main or significant consideration when investing in companies. If fund managers are making this marketing claim, they would be required to disclose to investors the methodologies that justify this claim. In addition, if a fund asserts that it is focused on climate risk, its disclosures should include the greenhouse gas (GHG) emissions of its portfolio companies.

“The SEC’s proposed ESG Disclosure Rule requiring standardised annual disclosures about engagement methodologies and metrics is critical,” said Kostyack. “If an asset manager wants to invest in oil companies while attracting customers with claims that it is attentive to climate risks, then at a minimum, it should be required to disclose in the fund prospectus and in SEC filings how its engagements with companies are designed to achieve meaningful emissions reductions.”

Similarly to the proposed disclosure rule for issuers, however, progress on this rulemaking appears to be stuck in time. Although the comment period ended over a year ago, a final version is yet to be released.

As such, Sierra Club recently urged the SEC to follow through on its proposal and strictly limit ESG-related marketing of ESG integration funds. It also encouraged the regulator to limit ESG-related marketing to two other types of investment funds: ESG-focused, and impact funds.

“Some fund managers are trying to have it both ways: there’s a record number of fund names being changed to include the word ‘climate’ or ‘sustainability’, without any change in strategy,” Kostyack argued. “From an investor perspective, we think it is unfair to leave them without the most basic information about how fund managers are adjusting their strategies. Using the world ‘climate’ and not doing any work behind that is deceptive.”

Kostyack provided the example of BlackRock, which he said had been attracting customers by promoting a ‘climate-aware’ approach to investing while remaining one of the world’s most heavily invested asset managers in oil and gas. Among its ESG funds is the iShares Climate Conscious & Transition MSCI USA ETF, which holds shares in ExxonMobil, Chevron, ConocoPhillips, and other fossil fuel companies whose expansion plans are incompatible with global climate goals.

Last year, a Morningstar report  found that the number of US funds with climate-related marketing had grown from 200 in 2018, to 1,400 in 2023.

“With respect to ESG, and more specifically climate, there is a greenwashing problem,” said Kostyack. “It’s an issue that is distinct from the larger challenge of assuring that fund names align with actual conduct.”

In the meantime, fund managers’ are increasingly alert to the fact that a growing number of customers are concerned about climate change, and the risks it poses to portfolios. A recent survey from non-profit organisation Americans for Financial Reform showed that a majority of investors were seeking reliable, user-friendly information about companies’ climate-related financial risks.

“The SEC’s proposed ESG Disclosure Rule represents important progress on investor protection and should be finalised as soon as possible,” Kostyack insisted. “GHG emissions are driving an alarming increase in extreme weather events around the world. The energy transition, now moving at a record pace thanks to the exponential growth of renewable energy, also poses a threat to many businesses. Investors need to know which fund managers are investing in climate-savvy companies.”

Moving pieces

Although enhanced disclosures should help to reduce greenwashing risk in the fund industry, they alone won’t be enough to soothe the US’ ongoing ESG woes.

Rules and incentives in the real economy have to accompany disclosures in the financial industry, Kostyack insisted.

“I don’t want to overstate how much disclosure can achieve: it really isn’t sufficient by itself, and needs to be complemented by other forms of regulation,” he said. “The Inflation Reduction Act, caps on methane emissions, and new rules from the Environmental Protection Agency on soot pollution – all of those are critical.”

US fund managers and investors alike have been navigating a difficult path, caught between increased regulatory pressure on climate commitments and disclosures, and a staunch anti-ESG campaign in red states.

“Financial institutions have faced persistent attacks from right-wing, fossil-fuel backed politicians over their voluntary climate commitments, while new and pending regulations are forcing large asset managers to rectify their rampant greenwashing,” Sierra Club said in a statement this week.

The statement followed news that JP Morgan Asset Management and State Street Global Advisors had left the Climate Action 100+ (CA100+) initiative, which involves hundreds of institutional investors with tens of trillions of dollars under management, with a commitment to engage with major corporate polluters on climate disclosures and actions.

“There have been some aggressive moves by the anti-ESG crowd, largely funded by fossil fuel interests,” said Kostyack. “Many politicians from fossil fuel states, such as Texas, are very active in this campaign – pressuring BlackRock and others to essentially commit to a new generation of fossil fuel build-out, which generates all kinds of systemic financial risk.”

This week, BlackRock also said it would transfer its CA100+ partnership to a smaller international arm, pulling its corporate membership in the group.

This year, the stakes in this debate are perhaps higher than ever, as US citizens prepare to go to the polls to elect their next president. Although the election of a Republican candidate to the White House could further compound anti-ESG sentiment across the country, Kostyack does not think it will trample climate transition efforts that are already underway.

“There’s only so many politicians who will be able to put their finger in the dike and attempt to stop the energy transition – it has an inevitable momentum to it,” he said. “Even if the outcome of the next election had an impact, it would only be transitory and a bump in the road.”

Whoever is in the White House next will, of course, matter a lot – but certain policies can’t be rolled back, Kostyack assured. The Inflation Reduction Act, for example, introduced tax incentives that have led companies to make investments over several decades. Many businesses will also have adjusted their strategies in response to the new law, and are unlikely to turn back.

“The energy transition is a multi-decade phenomenon that’s well underway, and which involves a shift in hundreds of billions of dollars of capital reallocation from dirty to clean,” said Kostyack. “The clean sector is winning, and investors are becoming increasingly aware of it. The sooner they become aware, the better – which is why we fight for better disclosures.”

Recent estimates have shown that a new transition fund opens every day around the world. While the production of clean energy remains roughly on par with ‘dirty’ energy, on the demand side – clean energy dominates by far.

“The trends are moving in the right direction, but it isn’t happening fast enough,” said Kostyack. “We expect this to accelerate as the business case for decarbonisation becomes clearer. Every year, this process speeds up and more and more companies demonstrate that there is real money to be made, and far less volatility for investors participating in the transition.”

Regardless of the outcome of the next election, Kostyack stressed the central role that institutional investors would continue to play in keeping the ball rolling on the energy transition.

“Certain politicians are promising to take action if elected and may be able to accomplish some things on the margins – but nobody’s arguing that oil, gas and coal are the industries of the future,” he added. “The big institutional investors are getting this, and the money will keep flowing towards financing the transition. And for those who are enlisting politicians to try to stop it – that’s a failed business model that people are going to see.”

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