SEC greenwashing proposals don't find common ground

The Securities and Exchange Commission received hundreds of comments with varying degrees of disdain, praise and suggestions on two proposals aimed at combating greenwashing that, if implemented, would add a host of new requirements for fund managers.

The SEC in May continued its focus on environmental, social and governance investing by issuing two proposals to address greenwashing — when a fund or company overstates its ESG offerings. One proposal would require investment advisers and fund managers to disclose additional information on ESG strategies in fund prospectuses, annual reports and adviser brochures. The other proposal would expand the "Names Rule" under the Investment Company Act of 1940, which requires funds with certain names — such as funds that suggest a particular type of investment, industry or geographic area — to adopt a policy to invest 80% of their assets in the investments suggested by that name. The latter proposal would subject fund names with terms such as "growth" or "value" and those indicating that the fund's investment decisions incorporate one or more ESG factors to the Names Rule.

The asset management community largely opposed the proposals in comment periods that each ended Aug. 16.

BlackRock Inc., based in New York and the world's largest money manager with $8.49 trillion in assets, said the SEC's ESG disclosure proposal is "overly complex and prescriptive," and does "not appear to be calibrated to the well-established definition of materiality," in a comment letter.

The Investment Company Institute, a Washington-based trade group representing regulated investment funds, said in a separate comment letter that some new disclosure requirements in the proposal "could unintentionally increase, rather than mitigate, the risk of investor confusion. In addition, the prescriptive requirements would impose costly burdens on funds without appreciable benefit to fund investors."

In a comment letter of its own, the Managed Funds Association, another Washington-based trade group that represents hedge funds, said the disclosure proposal would create investor confusion by overemphasizing otherwise immaterial factors.

"The proposal would render the term ESG meaningless by capturing strategies that no reasonable person would consider ESG-focused and requiring those funds to issue overly broad and indiscriminate disclosures," said Bryan Corbett, president and CEO of MFA, in a statement. "That's bad for investors in private funds who are interested in their ESG impact. It will set ESG efforts back by years and will make it challenging for ESG efforts to evolve over time."

The main criticism several commenters had centered around was the three types of ESG funds outlined in the disclosure proposal, each with varying requirements — integration funds, ESG-focused funds and impact funds.

Under the disclosure proposal, an integration fund is a fund that considers one or more ESG factors alongside other, non-ESG factors in its investment decisions.

Brian D. McCabe, Boston-based partner in Ropes & Gray LLP's asset management practice, said the proposal's description of an integration fund is broad enough to place nearly any fund under its purview because every fund considers elements of ESG in some capacity. "Do you think a manager isn't going to consider whether a particular portfolio company's governance structure is appropriate for an investment?" Mr. McCabe said.

Lance C. Dial, a Boston-based partner with Morgan, Lewis & Bockius LLP, had a similar view. "Every manager should be thinking about the benefits and costs of having dual-class stock or having a staggered board," Mr. Dial said. "These are relevant governance issues that can affect the value of a security."

ICI, MFA and other commenters recommended that the SEC modify the proposal and not require integration funds to produce added ESG disclosures.

BlackRock suggested in its comment letter that the SEC clarify its definition of an ESG-focused fund because the proposal is too broad and "may create investor confusion."

Separately, BlackRock worried that the "granular nature of requirements" laid out in the proposal "will inevitably lead to the disclosure of proprietary information about these strategies, reducing the competitive advantage of those unique insights."

Disclosing information such as a fund's proprietary ESG rating system could harm a fund's ability to differentiate itself in the marketplace, Mr. McCabe said. "What has been your secret sauce could potentially be diluted," he added.

But the ESG disclosure proposal also has plenty of supporters.

Christine Chang, an investment officer in liquid defensive and diversifying strategies for the $22 billion Hawaii Employees' Retirement System, Honolulu, said ESG can be additive to returns and is a great risk mitigant. "Companies that are not prepared for the impacts of climate change are not going to do well," she said. "Companies that don't pay attention to issues that stakeholders care about are not going to do well and, of course, governance has always been a key part of risk assessment."

Ms. Chang is a proponent of the proposal for establishing a uniform mechanism to assess funds' ESG practices as well as for requiring ESG-focused funds to disclose additional information regarding the greenhouse gas emissions associated with their investments.

"ERS has the obligation, as a state agency, to consider the impact of investment plans, decisions and strategies on the state's ability to achieve net-zero emissions by 2045 while maintaining our primary purpose of generating returns for our retirees," Ms. Chang said in a interview. "It would be very helpful to have standardized quantitative measures of greenhouse gas emissions because it would allow for two things: one, an apples-to-apples comparison across funds, and two, a comparison over time. Having quantitative measurements allows investors to track improvement, or lack thereof, over time."

The Hawaii pension fund doesn't have the resources for its staff to read through all the varying ESG disclosures funds currently publish, Ms. Chang said. "It's difficult when each fund has its own custom ESG report; it's simply not possible to comb through all of them and decide how to equate one set of reporting to another without a dedicated team," she said. "So to have standardized reporting put in the same place and in the same format will be very helpful for aggregation to a total plan-level view."

Lindsey Apple, Boston-based proxy voting and engagement lead and a member of the sustainability research team at Mirova, a global investment affiliate of Natixis Investment Managers specializing in sustainable finance with $24 billion in assets under management, fully supports the proposal.

Though she understands the concern from some asset managers on the level of disclosure the SEC is proposing, Ms. Apple "only sees positive impact for" Mirova and investors. The proposal "will create a classification system that will enable the end investor to delineate the shops that mildly integrate ESG from the ones that have a really robust, thoughtful approach," she added in an interview.

Ms. Apple would like the SEC to make tweaks to its fund classifications in a final rule so they more closely align with existing frameworks in Europe, such as the Sustainable Finance Disclosure Regulation.

"We really think in order for this to be beneficial and to serve and protect the investor, global consistency is key," Ms. Apple said. "There's already a classification system that's understood by the marketplace, so more alignment with SFDR would be preferable in our view and would benefit the investor the most in order to have that comparable information."

In a separate comment period, the SEC also received some pushback for its Names Rule proposal.

Commenters such as T. Rowe Price Associates Inc., a Baltimore-based sponsor and investment adviser to more than 200 proprietary mutual funds and exchange-traded funds that represents about $657 billion of T. Rowe Price Group Inc.'s $1.3 trillion in AUM, said in a comment letter that the Names Rule should not be expanded.

"We strongly oppose this proposed expansion, which we believe would result in a more complex, subjective version of the Names Rule that does little to help investors," T. Rowe Price said in its comment letter.

If the proposal were to go into effect, Ropes & Gray's Mr. McCabe suspects that "you will find fewer people using 'sustainable' terms in their names, as folks are forced to think about what that means. Having 80% invested in something suggested by your name sounds easy until you start trying to figure out what would satisfy a particular term."

Morgan Lewis' Mr. Dial expects there would be more funds "named after mountain ranges or bodies of water as opposed to trying to describe their investment strategy," if the proposal was finalized.

However, fund strategies are unlikely to change, he added.

"You don't change the fundamentals of a car because of a new bumper regulation or a new advertising regulation, and I think the same is true here," Mr. Dial said. "The portfolio managers and the analysts who manage these funds come up with what they think is a strategy for investing money that generates alpha and positive returns, and I don't think they're going to want to change that just because of a new regulation regarding the name when they can probably get the same result through concerted advertising and marketing."