SEC’s ESG integration proposals divide industry

The Securities and Exchange Commission is rewriting rules in hopes of stemming greenwashing, and how it distinguishes between funds that merely consider ESG factors and those that focus on them could affect the names those products can have.

That could include, for example, whether a fund that uses ESG considerations among many other factors can actually call itself ESG and if it will be subject to less stringent disclosure requirements than a product that uses ESG as a primary focus.

Commissioner Caroline Crenshaw, speaking Wednesday at the US SIF Forum, said the SEC wants to hear from the industry as it considers what the final version of proposed amendments to its fund names rule will look like.

“Data is at the top of that list. The more you can give concrete data … the more effective [input] will be,” Crenshaw said. “Don’t just say you don’t like something. Explain to us how you would draft it differently.”

She also encouraged stakeholders to set up meetings following the comment letters they submit, which can help draw attention to the points they make in writing.

The proposed change is “one of our most common-sense rules,” Crenshaw said, adding it brings a 20-year-old regulation in line with the expectations today’s investors have. “If a fund’s name suggests that it invests according to certain parameters … then it should in fact invest according to those parameters.”

As part of the proposals, the SEC is drawing distinctions among “integration funds,” ESG-focused funds and impact funds. Integration funds include a long list of products that have added ESG language around their investment processes, even if the products don’t include ESG as part of their names.

WHAT’S IN A NAME?

Part of what the agency is asking stakeholders is whether integration funds should be prohibited from including ESG in their names, as proposed — or whether including “integration” or another word as part of a name alongside ESG would be enough to prevent investors from being misled.

In its proposed amendments for investment advisers and companies, the SEC would require ESG-focused funds to make disclosures about their greenhouse gas considerations and report their carbon footprints and the portfolio’s weighted average carbon intensity. Funds that don’t consider emissions would not be subject to that. But ESG integration funds with carbon considerations would have to disclose their methodology and data sources, the SEC noted.

DIFFERENT TAKES

Fund companies should not be given free rein to determine what is material for the sake of disclosures, Michael Kramer, owner of Natural Investments, said at the US SIF conference.

“We know what they will choose if given the choice,” Kramer said, adding that retail investors would be misled by ESG integration funds.

“The public is being duped. They don’t know the nuances of the space,” he said. “I’m opposed to this idea of ESG integration being a sanctioned area of our industry. It is a weak, poor standard.”

But in general, the sustainable investing world does not appear to be strongly opposed to ESG integration funds, even if there is a need for more disclosure.

The SEC’s proposed rules show that the regulator’s “intent is on course,” said Bryan McGannon, director of policy and programs at US SIF, in an interview following Crenshaw’s presentation.

“They have put serious thought into it, and these are obviously complex rules. And we are still delving into them,” McGannon said. “We want to make sure that the proposals, when they get finalized, are meaningful and do serve the purpose of helping investors understand what is in the product and how the product works.”

The two proposed rule amendments represent the most important regulatory developments for sustainable investing in recent memory, he noted.

How the agency draws a line between ESG-focused funds and impact funds will be important as well, and it is crucial that the language in the rule changes encourages enforcement under different SEC regimes, McGannon said.

Panelists who spoke during a session on greenwashing weren’t against the idea of ESG integration funds as a concept.

“I don’t think ESG integration in itself is a greenwashing problem. It’s all about how it is represented to the clients and the public,” said Leslie Samuelrich, president of Green Century Capital Management and ESG Clarity U.S. Committee member.

The SEC’s proposed rules could clear up confusion, but product providers must communicate with clients about what they do, she said. If firms use ESG factors to help reduce risk and see higher long-term returns, rather than for the sake of impact, that should be made clear, for example.

“Mainstream firms decided [they] can capture the market share for people who want to make an impact,” Samuelrich said. “Sustainability means something different to everyone, but it does convey that it is something more than using ESG data.”

In the absence of standards and regulation around ESG, Morgan Stanley, like others, built a framework to vet the authenticity of products, looking at “intentionality, inclusion and influence,” said Lily Trager, head of Investing with Impact at the firm. Among the roughly 350 asset managers that partner with the company, about 80% have ESG policies at the firm level, and they provide about 3,000 investment options available through Morgan Stanley, Trager said.

“When you start to peel back the layers … it’s quite the opposite,” she said. “Less than 20% of those strategies are in the Investing with Impact platform.”

Several years ago, when hundreds of mutual funds started dipping their toes into ESG, the result was providers mistakenly thinking that adding language to prospectuses to reflect what they already did in their fundamental analysis was what clients wanted, said Chris Fidler, senior director of product management at the CFA Institute.

“What happened along the way was cross communication,” Fidler said. “It was easy for them to adopt, but I don’t think that is what people wanted.”

The names of those products should be clear about their intentions, he noted.

“Managers need to be able to answer that question, but they need to it in a way that doesn’t confuse investing with values,” Fidler said.