• Tue. Nov 29th, 2022

SEC to tighten rules on funds qualifying as ESG

ByChad J. Johnson

May 26, 2022

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Gary Gensler, Chairman of the Securities and Exchange Commission.

Evelyn Hockstein-Pool/Getty Images

Fund managers should name their funds more carefully, under rules proposed by the Securities and Exchange Commission on Wednesday. A fund called growth or value would have to keep 80% of its investments in that category, according to the proposals, and those that call themselves green or low-carbon would have to explain how they meet their environmental goals.

“A fund’s name is often one of the most important pieces of information investors use to select a fund,” SEC Chairman Gary Gensler said in prepared remarks for a meeting of the SEC. committee in the afternoon. “[I]investors should be able to dig in to see what’s under the hood of these funds.

The SEC is increasingly focusing on environmental, social and governance, or ESG, investments. The rules come as the agency cracks down on investment funds calling themselves ESG without disclosing what the label means.

This week, New York-based mutual fund manager BNY Mellon Investment Adviser paid $1.5 million to settle the SEC charges it distorted ESG review he made investments. The bank did not allow administrative costs.

The commission approved two proposals on Wednesday, by a 3-1 vote, with Republican Commissioner Hester Peirce dissenting.

the first proposal would update a rule dating back to 2001, which states that 80% of a fund’s assets must be invested in the type of assets suggested by the fund’s name. The naming rule states that a biotech fund must hold biotech stocks, while an exchange-traded fund named for an index must be 80% invested in indexed stocks. In the 20 years since the adoption of this rule, however, loopholes have developed in its application.

The planned updates on Wednesday clarify that the name rule also covers fund names derived from strategies, such as growth and value. Names reflecting a focus on environmental, social and governance concerns should also maintain 80% of their holdings in ESG-selected securities.

The new rule would have new teeth. Funds should publicly identify holdings that fall within the 80% bracket. When the namesake holdings drift below the 80% requirement, the fund has 30 days to return to compliance.

“Names matter,” Gensler said, before voting to support the proposal, alongside commissioners Caroline Crenshaw and Allison Lee.

The new requirements would impact the mutual fund industry’s trading and compliance costs. SEC staffers estimated that the name rule update could affect 75% of funds in the market. Concerns about how the change could restrict the flexibility of fund managers were among the objections cited by Peirce.

the second proposal approved at Wednesday’s committee meeting would govern disclosures by ESG funds. Gensler cited an estimate that the universe of sustainable investment vehicles in the United States has grown to $17 trillion.

ESG strategies vary widely, Gensler said. Some funds screen certain industries. Others claim to have an impact through proxy initiatives and measuring portfolio company emissions or labor practices.

Under the ESG disclosure proposal, fund companies or investment managers that claim to consider ESG factors would have to detail what factors they consider and how they implement them. ESG-focused funds that aim to affect their companies’ greenhouse gas emissions should report their portfolio’s emissions metrics and annual progress toward their ESG goals.

Commissioner Lee said the reporting requirement would discourage “greenwashing” by funds that claim to focus on ESG factors but do not. Commissioner Peirce lamented that the new rules create new pressure points that activists could use to coerce investment firms.

“What we’re trying to address is truth in advertising,” Gensler said in a press conference after the meeting.

Fund industry professionals were not enthusiastic about the proposals. Eric Pan, chief executive of the Investment Company Institute, has pledged to take a close look at the rules with members of his trade association.

“The proposal for some funds to disclose emissions related to their holdings seems impractical – some information may not even be publicly available,” Pan said. “The Commission must be mindful of the costs of any new requirements – which will be borne by investors – as well as the benefits.”

The head of the investment funds practice at law firm Sidley Austin, Elizabeth Fries, was concerned that funds and advisers were pulling out of ESG investing, to escape the burden of the proposed rules. “They probably won’t help investors in the end,” Fries said of the proposals.

Complying with the proposals would be costly, Fries added. She expects the SEC to receive sharp comments from the fund industry.

Both proposals are now coming out for 60 days of public comment. If passed, fund managers would have one year to comply.

Gensler spoke out about the commission’s toughening up of ESG claims by investment funds. In a video posted on Twitter, he noted that there are at least 800 registered funds, with more than $3 trillion combined, that claim to invest in assets that achieve some sort of ESG goals. “But what information is behind these claims that the funds are green or sustainable?” asked the SEC chief.

Email Bill Alpert at [email protected] and Lauren Foster at [email protected]