In a three-to-one vote on May 25, 2022, the U.S. Securities and Exchange Commission (SEC) proposed two rules. The proposed rules for environmental, social and governance (ESG) disclosure would amend rules and forms to require registered investment advisers, certain advisers exempt from registration, registered investment companies, and business development companies to provide consistent, comparable, and reliable ESG information in disclosure to investors and reporting to the SEC. The amendments to Rule 35d-1 (the Names Rule) under the Investment Company Act of 1940 would update the scope of the rule, enhance certain requirements in the rule, require new disclosure for terminology used in a fund’s name, and add new recordkeeping and reporting requirements.
Rules for ESG Disclosure
The proposed rules for ESG disclosure would require new detailed ESG-related disclosures in fund prospectuses and statements of additional information in the management discussion of fund performance in fund shareholder reports, and in adviser Form ADV brochures. In addition, advisers and funds would be required to include census-type ESG-related information in their regulatory reporting on Form N-CEN and Form ADV Part 1A. Further, the proposed amendments would require certain environmentally focused funds to disclose portfolio level greenhouse gas emissions metrics. The proposed rule would create new categories for ESG strategies, and each category would come with unique disclosure obligations.
- ESG Integration: Strategies that consider one or more ESG factors as a part of their strategy but where ESG factors is not a dispositive investment criterion.
- ESG Focused: Strategies that consider ESG factors as the primary investment consideration.
- ESG Impact: Strategies that have a stated ESG goal and seek to achieve a specific and measurable ESG impact through investment activities.
Fund Names Rule
The proposed amendments to the Names Rule would expand the scope of the rule, clarify how the rule applies to derivatives investments, provide for when a fundamental 80% policy is required, provide for prospectus disclosure regarding the criteria that the fund uses in its name selection, require use of plain English for terms used in the fund names, provide guidance on use of ESG terminology in a fund’s name, provide updates to the rule’s notice requirement, confirm that compliance with the 80% investment policy is not a safe harbor, and prescribe amendments to Form N-PORT and new recordkeeping requirements.
Vote and Dissent
SEC Chair Gary Gensler and Commissioners Caroline Crenshaw and Allison Herren Lee voted for the proposed rules and Commissioner Hester Peirce voted against the proposed rules. In her dissent on the proposed rule for ESG disclosures, Commissioner Hester Peirce stated the proposed rule “avoids explicitly defining E, S, and G, yet implicitly uses disclosure requirements to induce substantive changes in funds’ and advisers’ ESG practices.” In her dissent on the Names Rule proposal, Commissioner Hester Peirce stated that “the application of the 80% investment policy requirement to names suggesting that a fund focuses on investments with “particular characteristics,” most prominently, those associated with ESG, will rely on subjective judgments.”
Full Analysis to Follow
The proposed rule releases contain requests for comment. Comments are due 60 days after the date of publication in the Federal Register. This a quick summary of two significant proposals aimed at providing investors with more consistent and decision-useful information about ESG themed investment products and processes. We will provide a more detailed analysis of each proposed rule in future publications.