Although largely understood standing for environmental, social, and governance issues, ESG has long struggled to establish consistent definitions among companies, asset managers, and investors. Nonetheless, accounting for ESG factors has flourished—the number of sustainable mutual funds virtually doubled between 2018 and 2021, growing to more than $350 billion in assets.
This rush of activity increases pressure to resolve the disconnect between inconsistent labeling and strong investor interest. In May 2022, the US Securities and Exchange Commission (SEC) proposed two rules to help close that gap and provide greater clarity.
5 Potential Impacts of the New SEC Rules
If approved as written, the proposed SEC rules will impact five key issues in the ESG investment space.
1. Disclosure Reigns
SEC Chair Gary Gensler likens seeing “ESG” on an investment product to seeing “fat-free” on a milk jug. “In that case,” he explained in a statement, “you can see objective figures, like grams of fat, which are detailed on the nutrition label.” Under the proposed rules, a similar sort of transparency would apply. An investment would be categorized as either an ESG Integration, ESG-Focused, or ESG Impact strategy and have to include publicly accessible descriptions of relevant factors, strategies, criteria, data, and metrics surrounding ESG factors.
2. Supercharging the E
The proposed rules would instruct any ESG-Focused investment that emphasizes environmental analysis to disclose its total greenhouse gas emissions. The required information includes the portfolio’s carbon footprint and weighted average carbon intensity figures as well as the methodology behind the data.
3. Clarity by proxy
Many investment firms build their ESG reputations on shareholder proposals and engagement. If they are an essential part of the investment analysis process, the proposed rules would necessitate that they clearly describe such efforts on ESG matters, including both formal and informal measures.
4. “Integration” Downgraded
Under the proposed rules, only investments that rely on ESG analysis for buying and selling decisions may include ESG in their name. Those that merely integrate ESG assessments in their broader investment analysis process may not.
5. Keeping score
As proposed, the new rules mandate that any fund with ESG in its name must maintain at least 80% of its holdings in ESG-rooted assets or risk losing the appellation. They also require ongoing monitoring of all fund holdings to remain in compliance; the investment manager has 30 days to adjust the portfolio if the fund drops below the 80% threshold.
No Sure Thing
As with any proposed regulations, the SEC solicited public comments on the ESG-related measures. Due by August 16, the feedback will help Gensler and the four other commissioners craft and approve the final draft of the new SEC rules.
Public and industry pushback is expected, and some of it will likely track objections from Commissioner Hester Peirce, who voted against the proposals. Although acknowledging that the catalyst for the proposed rules “is a legitimate concern about the practice of greenwashing by investment advisors and investment companies,” she questions the potential costs investment companies will bear to comply with the new ESG regulations, inconsistent data and definitions, and the SEC’s authority to enforce such measures. Resisting ESG has also become a cause célèbre of the Republican Party.
Absent strict industry standards, ESG disclosures will likely always remain open to interpretation. Yet with investors paying nearly 50% more in fees for sustainable mutual funds than for conventional funds, increased oversight could offer benefits beyond transparency and clarity.