The Securities and Exchange Commission last month proposed amendments to specific rules and reporting forms under the Investment Advisers Act of 1940 that would require registered investment advisers and exempt-from-reporting advisers to reveal more information on how they consider environmental, social, and governance factors in their advisory activities.
“The proposed rules and form amendments are designed to create a consistent, comparable, and decision-useful regulatory framework for ESG advisory services and investment companies to inform and protect investors while facilitating further innovation in this evolving area of the asset management industry,” the SEC said in a statement on May 25 announcing the proposed changes.
The SEC is focusing on the inconsistency of ESG-related information being made available to investors. Critics of ESG metrics have noted that there is no standard for ESG-related details, even as investor demand for ESG strategies increases.
According to the US SIF Foundation’s 2020 Report on US Sustainable and Impact Investing Trends, $17.1 trillion, or one of every three dollars under professional management in the United States, was managed based on sustainable investing strategies.
“The ESG industry now has sway over more investor dollars than the entire GDP of Europe. Yet, asset managers like Blackrock and the proxy advisors behind them like ISS ESG deny investors information on the actual ESG strategies they employ,” said Bryan Junus, Chief Analyst of The Corporate Citizenship Project, a think-tank focused on a data-driven approach to corporate governance issues.
ESG standardization and transparency have been an issue for investors because ESG encompasses a variety of strategies. Some funds do not consider certain industries, while others include them. Some strategies may track board votes or make claims about greenhouse gas emissions or labor practices, while others might focus on other issues. Yet others might track an outside index.
The amendments to the Investment Advisers Act seek to provide more consistent and comparable information for investors regarding ESG factors. SEC Chairman Gary Gensler said that if the changes are adopted, “it would establish disclosure requirements for funds and advisers that market themselves as having an ESG focus.”
The proposed changes would revise a form to collect additional data from investment advisers related to the use of ESG considerations in their advisory business and change another form to include information regarding the impact of ESG factors on registered investment advisers. The amendments would also create three classifications of ESG-related strategies: ESG integration, ESG focused, and ESG impact.
ESG integration weighs various ESG factors and non-ESG elements such as financial metrics. These metrics may include whether a fund tracks an index, excludes or includes certain types of assets, uses proxy voting or engagement to achieve objectives, or aims to have a specific impact.
ESG-focused strategies concentrate on one or more ESG aspects. Funds would have to disclose details about the criteria and data they use to reach investment goals, as well as more specific information about their strategies.
ESG impact strategies are intended to create ESG-related benefits, such as advancing the availability of clean water.
Even before it proposed the amendments, the SEC demonstrated that it meant business regarding ESG transparency. The agency settled charges on May 23, two days before the SEC announced its proposed amendments. It imposed a $1.5 million penalty with a mutual fund adviser over alleged misstatements and omissions in fund disclosures regarding ESG factors. According to law.com, the adviser said the investments had undergone an ESG quality review when it did not have such a measure. This was the first SEC enforcement action taken regarding ESG issues in 14 years, according to the publication.
According to The Corporate Citizenship Project, the SEC comes short by focusing solely on asset managers.
“Behind asset managers like Blackrock are proxy advisors like ISS. Very few people outside the financial services industry know that proxy advisors greatly influence how asset managers make investment decisions. We understand that many asset managers essentially ‘outsource’ their ESG work to ISS and others and make their investment decisions accordingly,” explains Janus.
As Janus sees it, ISS ESG has a significant conflict of interest. “ISS ESG provides ESG ratings and so-called ESG ‘consulting’ services to public companies to boost their ESG ratings. Asset managers relying on ISS for ESG ratings may favor the companies that have paid ISS consulting fees rather than those that are the best corporate actors. If the SEC is serious about protecting investors from misleading ESG claims, they must also regulate proxy advisors and compel proxy advisors like ISS to choose either to provide ESG ratings or ESG consulting—not both.”
Investor demand for ESG funds and advisory services has climbed in the 21st century as investors have increasingly considered sustainability factors in their investment decisions. In the 1970s and 1980s, some asset managers began to include what would eventually be called ESG factors into funds with social and environmental investment objectives. In the 1990s, the first “socially responsible” indexes debuted.