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The US SEC aims to subject the US finance sector to tighter ESG regulation

© Shutterstock / AevanStockthe logo of the SEC on a wall

The US Securities and Exchange Commission (SEC) has announced a proposal for tighter regulation of ESG funds.

The ESG regulation announcement comes alongside news that it has fined Bank Mellon $1.5 million for misstatements over investment policies for some of its ESG mutual funds. This appears to be part of an attempt to address concerns about greenwashing in the financial markets and is the first such action undertaken by the SEC. Such concerns have grown given the rapid growth in the market.

Global ESG asset growth

According to asset flows data from investment research specialist Morningstar, in 2021 financial inflows reached an all-time high of EUR 20 billion and assets surpassed EUR 1.3 trillion. Estimates have suggested that current global ESG assets constitute 10% of the market. Such growth makes investor understanding of exactly what they’re investing in a concern to regulators.

Unsurprisingly, opponents have expressed concern about asset managers facing higher costs due to an increased ESG reporting burdens. Others suggest that the agency may be overstepping in pushing investors towards frameworks only favoured by certain investors.

Why are the SEC proposing alternative ESG disclosures?

The reality is that such market and investor concerns need to be addressed if the ESG market is to continue to mature.

In a statement, the SEC said that some of the relevant funds over which the company had oversight had ‘not always received ESG quality reviews’, even though relevant prospectuses had promised investments that “demonstrate attractive investment attributes and sustainable business practices, and have no material unresolvable environmental, social and governance (ESG) issues.”

While not admitting or denying any wrongdoing, the SEC said Bank Mellon agreed to a cease-and-desist order, a censure and to pay a penalty.

SEC chair Gary Gensler said: “It is important that investors have consistent and comparable disclosures about asset managers’ ESG strategies so they can understand what data underlies funds’ claims and choose the right investments for them…when it comes to ESG investing, though, there’s currently a huge range of what asset managers might disclose or mean by their claims.”

Given that investors make decisions based on such ESG disclosures, there is a problem if such disclosures are not transparent and assured – basically ensuring ‘truth in advertising’.

New SEC ESG disclosures process

The SEC’s new proposal would see clearer categorisation of certain types of ESG strategies and require funds and advisers to provide more specific disclosures in terms of fund prospectuses, annual reports and adviser brochures – all based on the ESG strategies they actually pursue.

There are also some more specific proposals around particular aspects of how to address ESG.

Greenhouse gas emissions disclosure

Under the new proposals, funds focused on the consideration of environmental factors generally would be required to disclose the greenhouse gas (GHG) emissions associated with their portfolio investments.

Impact also rises up the agenda, with a call for funds claiming to achieve a specific ESG impact required to describe the specific impact or impacts they seek to achieve, as well as proposing a summary of their progress on achieving those impacts.

At the same time, the proposals would have an impact on shareholder engagement, so that any funds that use proxy voting or other engagement with issuers as a significant means of implementing their ESG strategy would be required to disclose information regarding their voting of proxies on ESG-related voting matters and information concerning their ESG engagement meetings.

This is going to be of particular concern to many stakeholders given the shifting position on many major funds.

BlackRock reduces support for fewer climate proposals

The world’s largest asset manager Blackrock, for example, recently announced it is likely to support fewer climate proposals in 2022 than in 2021 (when it supported 47% of such proposals).

While the company said that was due to concerns about the short-term need for increased fossil fuels, as well as the micromanagement of portfolio companies, it was also said that current climate proposals are more complex than previous years.

Given that growing maturity and understanding goes hand in hand with complexity when it comes to addressing climate change, it’s important that scrutiny of the behaviour of financial institutions remains strong.

These new proposals, now open for public feedback for a sixty-day period, follow the March 2022 announcement of proposals surrounding public companies’ climate change risk reporting requirements.

While we don’t yet know how such proposals will pan out, this is a strong message about the increasing importance of credible, comparable and transparent action, as well as reporting, on climate and ESG issues.

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