Consultation responses broadly back naming and disclosure rule changes, but some call for further action.
Tough new US labelling and disclosure rules are a step in the right direction, but do not go far enough, according to respondents to a consultation on the proposed measures which closed this week.
The Securities and Exchange Commission (SEC) says the rules will give investors clearer information concerning ESG fund products, but while the feedback has been generally positive, some parties suggest there is much more to be done.
By contrast, one response was flatly opposed to the plans, describing them as “futile” and “arbitrary”.
At issue is the practice of greenwashing, in which dubious or over-stated claims are made for the environmental or social impact of green-labelled funds and other financial products. The lack of any agreed definitions has made life difficult for both institutional and retail investors seeking genuine ESG products.
Consistent and comparable disclosures
The SEC has put forward two main proposals to help tackle such problems.
First is an expansion of the scope of the rules governing the names given to funds. At present, a fund’s name – for example, Japanese large-cap stocks – must be supported by having at least 80% of its portfolio in such assets.
But this rule has never been applied to sustainable funds, something the SEC proposes to change. The change will cover also funds claiming to invest in growth or value stocks or to be following other investment themes.
Second is an increase in detailed disclosures about ESG strategies in prospectuses and annual reports. SEC Chair Gary Gensler said explained that the measures respond to growing investor demand for such details.
“It is important that investors have consistent and comparable disclosures about asset managers’ ESG strategies so they can understand what data underlies funds’ claims and choose the right investments for them,” he said.
“Inadequate and overwhelming”
The proposals were welcomed by non-profit advocacy group Environmental Defense Fund. “The SEC’s proposed standards will help meet investor interest in fuller understanding of available ESG offerings,” said Stephanie Jones, attorney at EDF. “The SEC is properly exercising its longstanding authority to protect investors from misleading marketing of investment products.”
The Center for American Progress, a think-tank once associated with Bill Clinton’s New Democrats, commented: “The Fund names rule urgently needs modernisation, given the pace and nature of the changes in the market today – change that is likely to accelerate as investment companies seek to attract investors interested in investments with particular characteristics, such as ESG-related factors.”
In its response to the SEC, it added: “While investors should research their investments, fund names are the entry point. And no one can blame investors for relying on fund names when faced with a proliferation of funds and information that is as inadequate as it is overwhelming.”
Andrew Behar, Chief Executive of As You Sow, a non-profit organisation supporting corporate social responsibility, told the SEC that the proposals were “a good first step” but that more needed to be done. Describing the current state of ESG investing as the “Wild West”, he wrote: “The new rule continues to use the flawed 80/20 framework. On the plus side, fund managers will be required to define ESG in the prospectus, how they vote proxies, and use a very simple set of standardised definitions and categories.
“While a good first step, investors were hoping for a new structure to close loopholes and eliminate confusion and misleading marketing.”
The CFA Institute, the international body for investment professionals, welcomed the SEC proposals. Writing to the commission, Paul Andrews, Head of Research, Advocacy and Standards, declared: “We appreciate the commission’s efforts to improve the quality and consistency of ESG related disclosures from investment firms, given the absence of a common reporting framework.”
Andrews said there was a need for regulatory action in response to rampant greenwashing by an industry driven by commercial opportunity. “Some investment firms are aggressively marketing ESG products and their ‘green’ investment prowess to meet growing demand from an entire generation of investors seeking exposure to ESG-focused strategies.”
Areas of misalignment
The US SIF, the Forum for Sustainable and Responsible Investment, was more critical.
“Despite the positive features of the proposed fund and advisor disclosure rule, there are several areas of misalignment between the proposal and both current fund practices and investor needs that threaten to undermine the effectiveness of the final rule,” wrote Policy Director Bryan McGannon. “These misalignments are likely to generate higher compliance costs than those reflected in the proposed rule and to diminish expected benefits.”
To remedy these misalignments, US SIF recommended measures including removal of the fund categories and requiring all funds that consider ESG factors to disclose the same information to investors, as well as a requirement for a qualitative explanation of shareholder engagement activities instead of one metric on the number of meetings held.
It also called on the SEC to strengthen the Names Rule proposal by clarifying the definition of funds that may not use ESG or sustainability terms in the fund name.
There was also a note of caution also from the Investment Adviser Association. It told the SEC: “While we are generally supportive of the proposal, we have concerns about its broad scope, which we believe could obscure rather than clarify salient information for investors.
“We are also concerned that the detail and specificity of information required to be disclosed could, paradoxically, be misleading in overemphasising some factors over others.”
But this was a ringing endorsement compared with the reaction of the American Enterprise Institute think tank. “Because ESG investment choices (or practices) by their very nature are political, there can be no uniform definition of ESG investment that is not arbitrary.
“Accordingly, the SEC quest for ‘a consistent, comparable, and decision-useful regulatory framework for ESG advisory services and investment companies to inform and protect investors’ will prove futile.”
Following the consultation, it is thought the SEC will seek to introduce new rules by October, ahead of Congressional elections that could see a majority for Republicans who may object to the changes.