The Securities and Exchange Commission needs to simplify proposed rules to require more disclosure from funds touting their environmental, social and governance factors, or else the agency will fail to eradicate so-called greenwashing, investment and advocacy groups are warning.
Investors of all sizes, including ESG-focused ones, as well as financial advisers and portfolio screeners, agreed that the agency has the proper intent in wanting more clarity from funds that claim sustainable factors. In a series of comment letters filed this week, however, the firms spelled out concerns that the rule as currently written would create confusion, increase compliance costs, and could allow funds to create a false impression of sustainability levels, or greenwashing, a practice in which a firm overstates its environmental concern.
The SEC voted 3-1 in May to propose requiring mutual and exchange-traded funds purporting to consider ESG factors to provide investors information about those factors, their strategies, and the criteria used to achieve their investment goals. SEC Chairman Gary Gensler said at the time that the proposal will help investors better understand what funds and advisers mean when they claim to be sustainable.
Comments were due Tuesday.
One of the top complaints from the industry is the proposal’s plan to divide funds into three categories: integration funds, which incorporate ESG factors among many other considerations; funds that focus on at least one or more ESG factors by using them as a significant or main consideration in selecting investments; and impact funds that have a core ESG objective, as opposed to a financial objective.
Integration funds, the lowest tier, would be required to summarize how they incorporate ESG into the decision-making process, such as which particular ESG factors the fund considers and their level of importance in the investment selection process. They would also have to explain how they consider greenhouse gas emissions in the portfolios if the funds reference emissions as a specific factor.
The SEC’s definition of an integration fund might go beyond what a lot of fund managers that mention ESG might actually be considering, said Aron Szapiro, head of retirement studies and public policy at Morningstar Inc.
“It’s not clear to us if these funds would drop the mention of ESG in their prospectus and the use of it, which could be useful in avoiding risks, or if they would say, ‘yeah, we are an integration fund’ and explain what they’re doing, but it might be too confusing to investors,” Szapiro said in an interview.
“The issue here is that we don’t really want funds that use ESG in an incidental or occasional way,” he added. “It’s not core to what they’re doing to be defining themselves as integration funds. I just think that word is confusing.”
Meanwhile, ESG-focused funds would have to go further, such as using a tabular format to report their considerations, and disclosing whether they use proxy voting or engagement with companies as a significant part of their strategies. They would also have to report their use of third-party data, including any ESG scores or ratings.