SEC proposes changes to tackle fraud in ESG

Learn how proposed requirements may make it easier to find climate-friendly investments.

By GreenPortfolio Team

May 31, 2022

Ny stock exchange

In March 2022, the Securities and Exchange Commission (SEC) proposed new rules which would require publicly traded companies to further disclose risks related to climate change. Now it appears that the SEC wants to increase transparency and disclosures of Environmental, Sustainable, Governance (ESG) funds through two new proposals.

 

GreenPortfolio strongly supports the SEC’s efforts to reduce greenwashing and help retail investors find stocks, bonds, and ETFs that support their values and build a clean energy future. A brief overview of these efforts is described below and we will provide updates as these proposals move forward.

MAKING SURE FUNDS THAT HAVE ESG IN THEIR NAME ACTUALLY ARE

For some time, GreenPortfolio has been warning retail investors to closely examine the constituent holdings of funds labeled “ESG” or “Green” because there may be bonds or companies included that do not have a positive climate impact.

 

This SEC Proposal would amend the already existing “Names Rule” to include ESG marketing efforts. Currently, this rule requires “that a fund with a name that suggests a focus on a particular type of investment, industry, country or geographic region, must invest at least 80% of its assets consistent with that suggested focus.”

 

This amendment would require that funds which use terms such as ESG, green, or sustainable would have to meet this 80% threshold in the future. Additionally, “the proposed rule would deem it materially deceptive or misleading for a fund to use ESG terminology in its name if it gives no greater weight or prioritization to ESG factors than to other investment factors.”

corporate building esg disclosure

While this is indeed a step in the right direction, GreenPortfolio is still concerned about the use of these terms with retail investors. One concern is that this 80% threshold would still leave plenty of room for the inclusion of securities that do not meet someone’s understanding of a sustainable or environmental investment. Indeed, 20% of a fund could be managed outside of this framework.

 

There’s the additional concern that ESG methods are not necessarily meant for measuring climate impact. Even within the 80% of fund constituents which must be managed within an ESG framework, there could be a lack of impact because the framework is designed with risk mitigation as the priority. This is partially addressed in the SEC’s second proposal, but the concern will remain that ESG does not equate with positive climate impact.

REQUIRING FUNDS TO DEFINE THEIR ESG METHODS AND DISCLOSE ENVIRONMENTAL IMPACTS

The second proposal would require managers of ESG funds to disclose their ESG strategies so that retail investors can better understand how and why constituents are included. This would greatly improve the transparency of how ESG metrics and methods are currently managed and hopefully force the flimsier funds in this space to either be renamed or retooled.

One aspect of this proposal which is particularly key is that “funds focused on the consideration of environmental factors generally would be required to disclose the greenhouse gas emissions associated with their portfolio investments.” The fact that this has not been included in these types of funds thus far has always been concerning to GreenPortfolio, so it is great that investors will now have access to this type of information. The SEC goes even further though, proposing that “funds claiming to achieve a specific ESG impact would be required to describe the specific impact(s) they seek to achieve and summarize their progress on achieving those impacts.” Forcing fund managers who promise impact to measure and track said impact is an important step in the right direction. Up to now, it has been difficult to determine if a fund is achieving any of the impact which they are purportedly selling. While these disclosure requirements will not ensure impact, they are an important step towards better transparency.

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PROPOSED DISCLOSURES SHOULD REDUCE FRAUD AND SUPPORT INVESTMENTS WITH TRUE IMPACT

On the whole, these proposals should be a positive step in the right direction against fraudulent funds which charge higher fees in exchange for supposed increased impact. It will also require increased rigor for ESG and impact-minded fund methodologies, though there is still concern that there remains room for constituent holdings that do not meet disclosed standards. Nonetheless, GreenPortfolio strongly supports any steps that make it easier for people to ensure that their investments have a positive climate impact.

sunlight hitting leafy green tree

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