ESG Investing at a Crossroads
What the SEC’s climate rules could mean for the future of Environmental, Social, and Governance Funds
By Tracey Lewis, policy counsel for Public Citizen’s Climate Program
As temperatures rise around the globe, investors who care about climate are trying to put their money to work saving the planet.
Big asset managers have noticed the demand and are marketing funds with brands that promise to meet climate-focused investors’ needs. But these investors are often sold a bill of goods. For too long, asset managers have misrepresented to investors the nature of their portfolio holdings by greenwashing, or making false, misleading, unsubstantiated, or incomplete claims about the sustainability of services, products, or business operations.
Regular 401K investors might be shocked to find their investments in “fossil free” funds sometimes aren’t so fossil free. It’s difficult even for experts to navigate climate claims and inadequate greenhouse gas disclosures, and asset managers take advantage of that knowledge gap by touting dirty funds as clean.
This problem is big enough that the federal government has stepped in. The Securities and Exchange Commission (SEC) recently brought an enforcement action against BNY Mellon Investment Advisers for making unsupported claims about its approach to vetting investments based on environmental, social, and governance (often known as “ESG”) factors. Now, the SEC has proposed two rules that could help clean up this market in a major way— the Fund Names and Fund Disclosure rules.
If adopted, these rules would let investors know where their money is flowing, and protect a right to truthful disclosures from asset managers.
What Is ESG, and What Are the SEC’s Proposed Rules?
The goal of the SEC’s proposed rules is to impose some order on the proliferating “green” fund market and the larger universe of environmental, social, and governance investment offerings. The rules seek to end asset manager greed while being responsive to investor needs. This is accomplished by updating long standing rules about fund names and the information funds must disclose. They’re a strong step forward, giving investors truthful, non-greenwashed disclosures to use in evaluating their existing and potential investments.
Since 2001, the SEC’s Fund Names rule has required funds with names that suggest a particular focus—such as a particular sector or region—to invest at least 80% of their assets in a manner consistent with that focus. The current proposal would extend this rule to fund names that invoke ESG factors. The rule would prohibit funds from using ESG-related terminology in a fund name if ESG inputs are only one factor among many that drive investment decisions. Under this proposal, if asset managers choose fund names with terms such as “growth” or “value” to describe investment strategies or use names that indicate the fund’s investment decisions incorporate one or more ESG factors using terms like “sustainable,” “green,” or “ethical,” those funds would be subject to the names rule.
Ultimately, this rule impacts how funds will market themselves. Asset managers who are serious about offering green options will stick around, while those looking to charge a premium without doing the work will exit this market. The likely revamping of ESG funds benefits all investors, but particularly retail investors who don’t have the time, information, or sophistication to parse detailed disclosures in the way that sophisticated institutional money can.
Another way the SEC is responding to investor needs is by requiring enhanced disclosures from ESG funds and creating a special category with its own requirements for climate and environmentally focused funds. The proposal would require asset managers of ESG focused funds to disclose both their fund strategies (for example: do they use an index, exclusionary or inclusionary screens or determine strategies by impact), and how those strategies are incorporated in their investment decision process. These fund strategies and manner of incorporation into investment decision-making would have to be disclosed in the prospectus.
Additionally, the proposed rule would require certain environmentally-focused funds to disclose Scope 3 greenhouse gas (GHG) emissions of their portfolio in their annual reports, thereby giving investors a meaningful metric to compare funds. Scope 3 emissions are those emissions emanating along the supply chain and from product use for each portfolio company. Although some asset managers don’t want to be required to assess and report the Scope 3 emissions, it is important that the SEC not backslide on this aspect of the proposal.
Investors are demanding reliable and comparable emissions data so they can invest with greater clarity and confidence. As Scope 3 emissions are the largest category of emissions, having this information helps investors hold asset managers accountable for greenwashed assertions made in annual reports and prospectuses. Without it, asset managers can grossly mislead investors on how climate or environmentally friendly their funds are.
Requiring all funds that consider GHG emissions to provide more detailed methodology reporting ensures investors have a more comprehensive view of the GHG emissions associated with the fund’s investment portfolio. This is what investors want and deserve.
Impact of New Rules
The SEC’s enforcement action in the BNY Mellon case, coupled with these proposed rules, sends a signal to asset managers and investors that there is a new sheriff in town. For the Big Four asset managers who attract the lion’s share of ESG investments—BlackRock, Fidelity, Vanguard, and State Street—and for others, the SEC is putting all funds and asset managers on notice that their previous ways of doing things are over. Some asset managers’ current offerings may not meet a heightened threshold under this new SEC disclosure framework, and they will need to improve their offerings or risk losing ESG investors.
Emboldened by shifting politics and multi-faceted coordination among GOP state leaders, current and former federal officials (like Mike Pence), and dark money interests—industry groups aren’t giving up without a fight. Instead, they have unleashed their well-trained anti-regulatory kraken to prevent ESG-focused funds from having to disclose details on the carbon footprints of their investment portfolios. Bloomberg reported that some asset managers believe GHG disclosure reporting is unworkable because emissions are not widely reported and the expense of researching them could be cost prohibitive.
However, we’ve seen this same tired argument trotted out in similarly sad dog and pony shows before. There is an ever-present risk to investors that asset managers will mislead them by overstating their ESG focus, and this greenwashing must come to an end. These rules will do just that and light a path towards decarbonized investments for those who want it.
Looking Forward
The Funds Names and Fund Disclosure rules each offer a well calibrated response by the SEC to investor needs for usable and comparable data on fund characteristics, strategies, and other important information—including GHG emissions in the case of environmentally focused funds—all of which will provide enhanced investor protections.
It is clear that investors are increasingly focused on climate considerations when making their investment decisions. They need quantitative and qualitative information on what they add to their investment portfolios—especially carbon intensity and financed emissions data. Investors need to know if their fund managers are truthfully reporting whether funds are aligned with their stated ESG goals—and rules requiring proper fund names and disclosures should meet that need.
For investors, reliable ESG investments are highly preferable to buying funds that are fundamentally misaligned with their values and goals. Under these proposed rules, ESG funds will be more transparent and trustworthy to both retail and institutional investors.