Tuesday, June 14. 2022
SEC Announces Rule Proposals to Enhance Disclosures by Certain Investment Advisers and Investment Companies About ESG Investment Practices
Though ESG strategies have been in use for decades, there has been a rapid increase in investor interest concerning these strategies in recent years. This is evidenced by considerable influxes of capital to ESG-related investment products and advisory services. To answer the growing demand, asset managers have created and marketed ESG products.
Should the proposed rules and form amendments be approved, they would:
- require additional specific disclosure requirements regarding ESG strategies in fund prospectuses, annual reports, and adviser brochures
- update Form N-CEN to make it applicable to all Index Funds (as defined in Form N-CEN) to provide identifying information about the index
- implement a tabular disclosure approach for ESG funds to allow investors to compare ESG funds at a glance
- require certain environmentally focused funds to disclose the greenhouse gas (GHG) emissions associated with their portfolio investments
In the same way that funds and advisers vary widely when defining ESG, there are also considerable differences in the data and measures used as part of ESG strategies. Disclosure requirements and a standard disclosure structure customized to ESG investing make it easier for investors to discern which investments or investment policies are associated with a particular ESG strategy. With these informative disclosures, a fund’s or adviser’s disclosure could more precisely gauge its actual consideration of ESG factors.
ESG Strategy Disclosure for Funds and Advisers
Under the rule proposal, a fund that considers ESG factors in its investment process would be required to disclose supplemental data regarding its strategy. The amount of disclosure required is based on how critical ESG factors are to a fund’s strategy. Disclosure policy follows a layered framework comprised of a summary in the prospectus and more comprehensive data in other portions of the prospectus, annual reports or in other disclosure documents, all of which would be reported in a structured data language.
Identified in the proposal are the following three types of ESG funds:
- Integration Funds are funds that integrate ESG factors alongside non-ESG factors in investment decisions would be required to describe how ESG factors are incorporated into their investment process
- ESG-Focused Funds are funds for which ESG factors are a significant or main consideration would be required to provide detailed disclosure, including a standardized ESG strategy overview table
- Impact Funds are a subset of ESG-Focused Funds that seek to achieve a particular ESG impact would be required to disclose how it measures progress on its objective
An adviser that considers ESG factors would be required to make comparable disclosures in their brochures regarding their consideration of ESG factors in the methods of analysis or investment strategies they seek and report specific ESG information in their annual filings with the SEC.
Additional Disclosure Regarding Impacts and Proxy Voting or Engagements
Under the proposed updates, certain ESG-Focused Funds would be required to provide supplemental information concerning their strategies. This would include information pertaining to the impacts they seek to achieve and key metrics to assess their progress. The updated rules would require funds that use proxy voting or engagement with issuers as a way of implementing their ESG strategy to provide additional information relevant to their proxy voting or ESG engagements, if appropriate.
GHG Emissions Reporting
The proposal would require ESG-Focused Funds that consider ESG factors in their investment strategies to:
- disclose additional information regarding the GHG emissions associated with their investments
- disclose the carbon footprint and the weighted average carbon intensity of their portfolio
- meet demand from investors seeking environmentally focused fund investments for consistent and comparable quantitative information regarding the GHG emissions associated with their portfolios and to allow investors to make decisions in line with their own ESG goals and expectations
Funds that do not consider GHG emissions as part of their ESG strategy would not be required to disclose this information. Integration funds that consider GHG emissions would be required to disclose additional information about how the fund considers GHG emissions, such as the methodology and data sources the fund may use as part of its consideration of GHG emissions.
Structured Data Language Format Requirement for ESG Disclosures
The SEC is also proposing that funds tag their ESG disclosures using the Inline XBRL structured data language which provides machine-readable data that investors and other market participants can use to more efficiently access and evaluate ESG funds. The SEC expects that the Inline XBRL requirements would enhance transparency and provide beneficial information to investors, assisting them in making informed choices based on their preferences for ESG investing.
Interested parties may submit feedback related to the proposed rule amendments. The comment period will be open for 60 days following publication in the Federal Register. For more details on submitting comments, see the Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices proposed rule on the SEC’s website.