BY: Taylor Miller, RBFL Student Editor
In June 2022, the Securities and Exchange Commission (SEC) announced a new proposed rule that would require certain disclosures from investment advisers and investment companies on their environmental, social, and governance practices. This rule follows in the wake of the European Union’s Sustainable Finance Disclosure Regulation passed in 2018. Though there are differences, both rules generally have a three-tiered disclosure structure based on divide how central ESG factors are to the fund’s investment decisions. It has been questioned, however, whether ESG deserves its own disclosure requirements.
SEC Commissioner Hester Pierce asks this exact question in her response to the proposed rule. By her reasoning, the threats posed by false ESG disclosures are already covered under enforcement proceedings for false information. In general, the SEC demands that material information regarding investment objectives, strategies, risks and governance be disclosed. While common sustainable investing strategies like the use of negative/positive screens or impact objectives would definitely fall under this requirement, solely relying on broad disclosures rules ignores two big issues: the expansive use of ESG factors and the relative confusion surrounding ESG.
Most recently, it was reported that $8.4 trillion dollars of assets under management in the US qualifies as a “sustainable investment”, representing 12.6 percent of total US AUM. Worldwide, the number is believed to be $35 trillion as of 2020. Analysts report that ESG AUM is on track to exceed $53 trillion by 2025, representing one third of global AUM. Despite a growing number of assets being categorized as sustainable investments, there is still inconsistencies over how people define and implement ESG factors and considerations. Two funds could both claim to be “sustainable” and claim to incorporate ESG factors into their investment decisions, but they could be doing it in completely different ways, both involving different risks, results, and considerations. The variation of ESG practices increases the risk of misrepresentation and investor confusion.
Whereas ESG strategies do generally fall under material information that is required to be disclosed, the growth of the field as well as the variety within demands that a formalized and consistent method of disclosure be implemented. By requiring consistent disclosure, investors will be able to inform themselves more easily on how funds view and utilize ESG strategies and make the best decision on which fund best aligns with their own values. Though the SEC proposed rule may not be perfect, it is a big step in consistent and decision-useful disclosures in an area that is only growing.
Enhanced Disclosure by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices, 84 Fed. Reg. 36654, 36658 (June 17, 2022) (to be codified at 17 C.F.R. 200).
Regulation 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector, 2019 O.J. (L 317) 2 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A02019R2088-20200712
Commissioner Hester M. Pierce, Statement on Environmental, Social, and Governance Disclosures for Investment Advisers and Investment Companies, U.S. Securities and Exchange Commission (May 25, 2022), https://www.sec.gov/news/statement/peirce-statement-esg-052522
U.S. SIF Foundation, 2022 Report on US Sustainable Investing Trends 2 (2022), https://www.ussif.org//Files/Trends/2022/Trends%202022%20Executive%20Summary.pdf
Bloomberg Intelligence, ESG assets may hit $53 trillion by 2025, a third of global AUM, Bloomberg Professional Services (Feb. 23, 2021) https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/