Statement on Proposed Rule Requiring Enhanced Disclosure by Certain Investment Advisers and Investment Companies on ESG Investment Practices

Source: Securities and Exchange Commission

The role of Environmental, Social, and Governance issues – or “ESG” – in investing has undeniably changed over time.[1] Investor demand for products and strategies that take into account ESG factors has increased dramatically over the past decade.[2] And, the asset management industry has responded to meet that demand.[3]

But the products and services offered are as diverse as the ESG nomenclature, with different funds and advisers focusing on different ESG factors, ascribing different import or weight to those factors, and setting different ESG goals (or no goals at all). And, funds and advisers employ diverse approaches to engaging with investee companies on ESG issues, such as using proxy voting, engaging management, or playing a more passive role by relying on ESG indices or third party service providers.

In the absence of a specific disclosure regime, funds and advisers employing ESG practices do not have clear guidance as to what information should be disclosed and in what manner. Additionally, with the spike in investor ESG demand, funds and advisers may be incentivized to overemphasize the role that ESG factors play in their portfolio management decisions. In other words, managers may use “ESG,” and loosely defined terms such as “sustainable” and “green,” as more marketing tool than investment thesis.[4] Indeed, our Division of Examinations has made such findings in the field, noting in an alert last year that staff were observing, for example: portfolio management practices that differed from client ESG disclosures; misleading claims relating to ESG approaches; and, proxy voting practices that were inconsistent with advisers’ stated approaches.[5]

And, with this absence of a cohesive framework, investors are left without accurate, reliable and comparable ESG disclosures that would allow them to: understand how funds and advisers are incorporating ESG factors into investment strategies; substantially differentiate between investment products; and, measure whether funds and advisers are meeting their stated goals.

Today’s proposed rule aims to address these problems.

A few general points on the proposal. First, as I noted, the proposal strives to achieve the goals of accuracy, reliability and comparability among the various ESG asset management practices and products. Clear and standardized disclosures allow investors to compare products and accurately price risks and opportunities associated with ESG practices.[6] This favors not only the investor who places a premium on ESG investing, but also potentially the investor who thinks an ESG issue is being overpriced. In other words, transparency around ESG, which is now a mainstream factor in investing, brings benefits to a variety of investors, and not just those who place a social benefit on ESG.

Second, the proposal fits within the Commission’s long-standing and well-established framework of requiring disclosure of material information to investors for decision-making. For example, funds have long been required to provide important information about a fund’s fundamental characteristics including investment objectives, strategies, risks and governance; and, registered advisers are required to provide key information about their methods of analysis and investment strategies.[7] Today’s proposal would fit ably within the existing regime.

Third, the rule is neutral as to the benefits or risks of ESG investing. The Commission’s interest is in the reliability and sufficiency of adviser and fund disclosures to investors and in providing a consistent and coherent framework in which investors can make informed investment decisions. In proposing today’s rule, the Commission is not weighing in on the advisability of ESG investing, or second-guessing the investment strategies of managers and funds. Rather, the proposal seeks to align investor expectations with manager practices through disclosure. I said it moments ago when we were discussing the Names Rule, but it bears repeating – investors have a right to know what they are investing in.

Turning to the proposed rule itself. Today’s proposal would require meaningful specific disclosure regarding ESG strategies in registration statements, the management discussion of fund performance in annual reports, and in adviser brochures, among other changes to certain advisor forms.[8] The level of detail required of any given fund or adviser will depend on the extent to which such manager considers ESG factors in its decision-making.

For “ESG-focused” funds – or those funds that either employ one or more ESG factors as a significant or primary component in their investment process or in their engagement with investee companies (or, funds that markets themselves as such) – we are today proposing certain minimum disclosure requirements. So, for example, a fund that has a stated strategy of achieving a certain ESG impact, would have to provide disclosures in their annual reports that summarize its progress in achieving those impacts in both qualitative and quantitative terms. As another example, if an ESG-focused fund states that it employs a proxy voting strategy, or will seek engagement with an issuer’s management as a means to implement its ESG strategy, today’s rule would require that fund to disclose information on how it voted ESG issues in proxies, or how it actually engaged management. Finally, ESG-focused funds will have to disclose standardized GHG emission metrics in the Fund’s annual reports, giving investors a meaningful metric to compare funds and a tool to potentially meet their own goals.

For “ESG integration” funds – or funds that consider one or more ESG factors among other factors in their investment process – today’s proposed rule would require more limited disclosure around how the fund incorporates ESG factors into its investment selection process. To the extent that an integration fund considers GHG emissions of portfolio holdings, such fund must describe how it considers those emissions and what methodologies it employs in measuring those emissions.

Note, however, the proposal does not require standardized quantitative disclosure of GHG emissions from integration funds that consider such emissions in investing, and I hope the public will comment on whether such standard quantitative metrics would be useful and should be required.

Finally, the proposed rule would also enhance regulatory reporting and require certain disclosures to be in structured data language, which will allow for better data analysis and industry trend reporting in the future.

The proposed rule takes a meaningful step toward giving investors the transparency they need to understand how funds and advisers are using ESG factors in their investment decisions, and to reign in marketing practices of exaggerating the use of ESG to attract business, and I am pleased today to support it. I look forward to hearing from the public on this proposal.

***

I would finally, once again, like to thank our staff from the Division of Investment Management, the Division of Economic and Risk Analysis, and the Office of the General Counsel for their tremendous work on this proposed rule. The final proposal reflects your careful consideration and steadfast efforts, and is a testament to your continued commitment, for which I am ever grateful. So, thank you. And, once again, I would like to extend my gratitude to the Chair and his staff for their leadership on this, and the other many rules that we have proposed.


[1] Proposed Rule, Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social and Governance Investment Practices, Rel. No. IA-6034 at 12-13 (May 25, 2022) (hereinafter the Proposed Release).

[2] See, e.g., id. at 7 and n.2 (citing U.S. Sustainable Investing Forum, The Report on U.S. Sustainable and Impact Investing Trends (Nov. 16, 2020)), and at 12-13 (noting the results of one survey indicating 42% of institutional investors say they consider ESG factors in investment decision making, and another survey of professional fund selectors and institutional investors noting that 75% and 77% respectively believe consideration of ESG factors is integral to investment decision making). See also PRI Annual Report 2021 (noting “[R]esponsible investment is no longer seen as a fringe topic, but is now a mainstream investment issue. Indeed, the PRI now has 3826 signatories (3404 investors and 422 service providers), representing collective assets under management of just over US$121 trillion as of 31 March 2021.” And, “PRI’s global signatory base represents more than half the world’s institutional assets.”); Edward Herilhy and Martin Lipton, Annual Meetings and Activism in the Era of ESG and TSR (harvard.edu) (May 19, 2022) (noting major asset managers have with increasing frequency been supporting activists on ESG issues); BlackRock 2020 CEO and Chairman’s annual letter (“[C]limate change is almost invariably the top issue that clients around the world raise with BlackRock.”); The Law and Economics of Environmental, Social, and Governance Investing by a Fiduciary (harvard.edu) (citing Goldman Sachs piece, “ESG investing, once a sideline practice, has gone decisively mainstream.”).

[3] See, e.g., The Division of Examinations Review of ESG Investing (April 9, 2021) (“In response to investor demand, investment advisers and funds have expanded their various approaches to ESG investing and increased the number of product offerings across multiple asset classes.”); U.S. Securities & Exchange Commission, Asset Management Advisory Committee, Recommendations for ESG (July 7, 2021) (“ESG investing has grown significantly in recent years; according to the ICI, ‘socially conscious’ registered investment products grew from 376 products/$254 billion in assets under management (‘AUM’) at the end of 2017 to 1,102 products/$1.682 trillion in AUM by the end of June, 2020.”); Boffo, Riccardo and Patalano, Robert, “ESG Investing: Practices, Progress and Challenges”, OECD, (2020) (noting that the “amount of professionally managed portfolios that have integrated key elements of ESG assessments exceeds USD 17.5 trillion globally, by some measures”).

[7] See, e.g., Proposed Release at 8 n.5, 17; Investment Company Act (“ICA”) Release No. 23064 (Mar. 13, 1998) (Form N-1A amendments focusing on prospectus disclosure); ICA Release No. 13436 (Aug. 12, 1983) (adopting Form N-1A); Investment Adviser Act (“IAA”) Release No. 3060 (July 29, 2010) (amending the Form ADV Part 2 “brochure” including disclosure on investment strategy); see generally 15 U.S.C. 80b-6 (imposing a fiduciary duty on investment advisers to provide full and fair disclosure of all material facts relating to the advisory relationship and imposing antifraud liability).

[8] Proposed Release at 20.