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SEC ‘Names Rule’ One Step Toward ESG Fund Integrity

US regulator urged to prioritise enforcement of new rule to prevent greenwashing.

Investors’ attention will turn to the upcoming ESG disclosure rule after the US Securities and Exchange Commission (SEC) adopted a new ‘Names Rule’ to improve accuracy and reliability of the naming of investment funds. 

Speaking to ESG Investor, Steven Rothstein, Managing Director for the Sustainable Capital Markets Accelerator at investor network Ceres, said changes to the Investment Company Act’s ‘Names Rule’ will provide “additional focus” for asset managers in their marketing of sustainable, climate or other ESG-related funds.  

It will also give investors “greater confidence” in the sustainable finance marketplace, he added.  

“As investors increasingly seek responsible investment options that consider climate risks, regulations that bolster confidence and prevent greenwashing are critical,” said Rothstein. 

“The SEC’s new rule will help ensure truth in advertising for fund names and allow investors to make more informed decisions. We commend the SEC for its ongoing efforts to provide the market with consistent, decision-useful information.” 

Rothstein noted that the SEC is yet to rule on the ESG disclosure rule, which aims to amend reporting rules concerning funds’ and advisers’ incorporation of ESG factors in their marketing material, such as prospectuses and annual reports.

The SEC is still reviewing feedback on the ESG disclosure rule – ‘Enhanced Disclosures by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices’.

The consultation for feedback closed on 16 August 2022.

Missed opportunity 

The Names Rule previously required that funds with a name that indicated a focus on a “particular type of investment” must invest “at least 80%” of its assets in the suggested type of investment.  

The new rules extend this “80% rule” to cover ESG investment strategies and require that fund names meet a “plain English meaning or established industry use”. Extending this rule should prevent situations where a fund technically conforms to the 80% rule but contradicts the fund name with the remaining portion of the holding.  

Jessye Waxman, Senior Campaign Strategist at US-based non-profit Sierra Club, also welcomed the adoption of the new rule, which will “help cut down on greenwashing and misleading marketing” to allow investors to invest in line with their values.  

Waxman did, however, criticise the SEC for failing to include a “key provision” in its final ruling preventing the use of ESG-related terminology for funds that “merely consult” ESG metrics.  

“This provision will be key to helping the SEC crack down on some of the most egregious greenwashing on Wall Street,” she added. “We look forward to that proposal being included in a separate rule update.”  

According to non-profit As You Sow, the final rule did not include a key section designed to prevent misleading labelling. Under the proposed rule, if funds considered ESG factors which were not the principal purpose of the fund’s investment strategy, it would have been materially deceptive and misleading to use ESG or a similar term (such as sustainable, green, impact, etc.) in the name.

This section was left out of the final rule.

“These new rules will help provide needed truth in advertising and make a statement that financial greenwashing with misleading or deceptive ESG labels is not acceptable,” said As You Sow CEO Andrew Behar.

“We see funds with ESG in their names holding dozens of fossil fuel extraction companies and coal-fired utilities. The plain English meaning of ‘fossil free’ should rule out these holdings.

“We call on asset managers to embrace the spirit of these rules and ensure that their ESG funds have holdings that align with the fund name and prospectus language.”

Challenge of enforcement

While Ceres’ Rothstein welcomed the new Names Rule, he underscored the importance of effective enforcement.

“It’s one thing to have a rule, but it must be enforced effectively,” he said, adding that the implementation the ESG disclosure rule and effective enforcement for both anti-greenwashing rules would move the market in a “significant way”.

The SEC announced this week that German asset manager DWS had been fined for misstatements relating to how it integrated ESG factors and data into its investment process.

According to a blog post by global law firm Ropes & Gray, the new Names Rule could pose liability risks by imposing “ostensibly objective standards on inherently subjective concepts”.

“And just who is to be the judge of the supposed ‘plain English meaning or established industry use’ of terms like ‘sustainable’, ‘green’, ‘socially responsible’, ‘growth’, and ‘value’?” it asked.

“The unfortunate answer is probably the SEC Enforcement staff, with the private plaintiffs’ bar to follow – meaning a serious threat of aggressive second-guessing as to how advisers approach thematic investing.  

“The implication is that full transparency is not enough.”

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

Copyright © 2023 ESG Investor Ltd. Company No. 12893343. ESG Investor Ltd, Fox Court, 14 Grays Inn Road, London, WC1X 8HN

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