Update considered the “natural next step” following SEC climate disclosure framework.
Continued delays to the US climate disclosure framework are holding up the US Securities and Exchange Commission’s (SEC) possible introduction of new sustainable fund-labelling requirements, according to industry experts.
“Guidance on labelling sustainable and ESG funds would be the natural next step for the SEC to take,” Gregory Hershman, Head of US Policy at the UN-convened Principles for Responsible Investment (PRI) told ESG Investor.
Such regulation would require US-based asset managers to ensure the names of sustainable funds better match their contents, therefore reducing the risk of greenwashing.
“If I had a nut allergy and ate something that said ‘peanut free’, when it actually contained nuts, I would be in hospital and preparing a lawsuit,” said Andrew Behar, CEO of shareholder advocacy non-profit As You Sow. “If a fund labels itself as a low carbon fund, but actually holds a number of the biggest oil and gas companies, then its contents don’t really match the label. It undermines the efforts of managers that have launched credible fossil-free funds.”
In March 2020, the SEC asked for feedback on whether the Fund Names Rule should be updated. The rule requires funds focused on a particular type of investment – such as a large cap equity fund – to invest at least 80% of its assets accordingly. Some respondents said the rule does not extend effectively to thematic or sustainable funds, calling for additional fund-labelling regulation.
“The Fund Names Rule means a so-called fossil-free fund can still hold 20% fossil fuels,” said Behar.
Studies have highlighted that greenwashing is a problem in the US.
A report by sustainable investment data provider Util compared the listed company holdings of 281 US sustainable funds and assessed the degree to which they positively or negatively contribute to the UN’s Sustainable Development Goals. Funds marketed as sustainable are “commonly exposed to the same constituents as their vanilla counterparts”, the report said.
But continued delays to the SEC’s mandatory climate reporting framework for publicly-listed companies have pushed fund-labelling down the regulatory agenda for 2022.
Originally promised by October 2021, the framework is now expected in the coming weeks. The public consultation on plans to introduce climate-related disclosure requirements for companies closed on 14 June last year and was widely supported by investors.
The framework is understood to have been delayed due to continued debate around the inclusion of Scope 3 emissions in reporting requirements, which raises potential liability issues between regulated entities.
In lieu of guidance from the SEC, another option for fund managers and investors is to turn to voluntary frameworks.
In November 2021, the CFA Institute published its Global ESG Disclosure Standards for Investment Products. The standards aim to help investors distinguish between funds claiming to have integrated ESG factors, and can be applied to all types of investment vehicles and asset classes.
“Our disclosure requirements aim to give investors a comprehensive understanding of how investment products have been put together,” said Chris Fidler, Senior Director for Global Industry Standards at the CFA Institute.
Fidler previously told ESG Investor that the standards are designed to be of use in all jurisdictions regardless of whether they have mandatory fund-labelling rules in place, such as the EU’s Sustainable Finance Disclosure Regulation (SFDR).
Asset owners should be looking to closely scrutinise funds offered by asset managers, Hershman noted, including asking for information about why companies have been included within an ESG or sustainable investment product. They should also question why a fund has been rebadged as sustainable.
“Regulating fund names is a first step towards a European-style sustainable taxonomy, which would really outline what can be categorised as sustainable,” Hershman said. “But there is a lot more work to be done before getting there, including identifying whether the SEC would be the right authority to introduce it or if Congress would have to take it forward. The latter would introduce a number of political issues,” he said.