Overview
On May 25, the Securities and Exchange Commission (SEC) released a proposed rule requiring specific disclosures from certain investment funds and advisors on their environmental, social, and governance (ESG) strategies. While the SEC has long required funds and advisors to provide key information about the characteristics of a fund and an advisor’s business practice and strategy, the growing popularity of ESG-focused funds has prompted the SEC to propose a more targeted disclosure framework for ESG products and advisory services. Specifically, the SEC notes that greater consistency, comparability, and reliability is needed to help investors compare ESG strategies across funds and mitigate potential exaggeration, or "greenwashing," of ESG practices by funds and advisors. This action is the latest in a broader SEC effort to address how ESG factors are considered and disclosed to investors and follows a recent SEC proposed climate disclosure rule published in April, which imposed new climate disclosure requirements on publicly traded companies.
The proposed rule would amend the Investment Advisors Act and the Investment Company Act to impose new disclosure requirements on registered investment companies, investment funds, investment advisors, and certain unregistered advisors based on three types of funds/strategies:
- Integration fund – A fund that considers ESG factors among many others in their investment selection process
- ESG-focused fund – A fund that markets itself as ESG focused and relies on ESG factors as a significant or main consideration in its investment selection
- Impact fund – An ESG-focused fund seeking to achieve a specific ESG impact
Disclosures on ESG Strategy
- The proposed rule would require funds that consider ESG factors to disclose how they incorporate such factors into their investment selection process and their investment strategies.
- The level of detail required would depend on the extent of ESG considerations in the investment process:
- Integration funds, for example, would only be required to include a short narrative in their prospectus regarding how ESG factors are considered, with some additional detail required of integration funds that consider GHG emissions as a factor (i.e. the methodology relied on to assess greenhouse gas (GHG) emissions metrics).
- ESG-focused funds (including impact funds) would be required to complete an "overview table" subject to the tabular format illustrated in the rule, with more detailed descriptions included elsewhere in the prospectus. Specifically, the overview would include a brief disclosure on the primary factors of the fund’s strategy and any commonly identified ESG strategies/frameworks that the fund follows to allow investors to quickly compare across funds.
- Impact funds would additionally be required to describe how the fund measures progress toward the fund's stated impact, including how such progress is measured, the time horizon used to measure progress, and the impact’s relationship to the fund’s financial returns.
- Registered investment advisors and exempt reporting advisors would be required to make similar disclosures in their Form ADV Part 1 and Part 2A, subject to the same integration, ESG-focused, and impact categories.
Disclosure on Impacts of Proxy Voting
Funds that use proxy voting or engagement with issuers as a significant tool for implementing their ESG strategy must provide a brief narrative overview of how the fund votes proxies and any issuer engagement practices it deploys. Similar requirements would apply to registered investment advisors in the ADV Part 2A for proxy voting on behalf of client accounts.
Disclosure of GHG Emissions
The Rule would also require ESG-focused funds that consider environmental factors to disclose the carbon footprint and average carbon intensity of their portfolio. This would not be required of funds that state that they do not consider emissions as part of their GHG strategy.
Comments on the proposed rule are due 60 days after publication in the Federal Register. For additional information, the SEC’s accompanying fact sheet can be found here.
