The Securities and Exchange Commission (SEC) proposed changes on May 25, 2022, to the rules and disclosure forms pertaining to the ways advisers and funds incorporate Environmental, Social, and Governance (ESG) factors into their investment practices.

If adopted, the Proposed Amendment, formally called "Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices,” would require advisers and funds that claim to consider ESG factors to disclose additional information regarding their strategy.

According to the SEC, the Proposed Amendments would “promote consistent, comparable, and reliable information” for investors so they can “drill down to see what’s under the hood” of ESG funds. In a statement, SEC Chairman Gary Gensler said when he thinks about ESG funds he is reminded of walking down the aisle of a grocery store and seeing a product like fat-free milk. “What does ‘fat-free’ mean? Well, in that case, you can see objective figures, like grams of fat, which are detailed on the nutrition label.” Chairman Gensler would like ESG funds to be more like fat-free milk.

According to the Wall Street Journal, assets in funds that claim to focus on ESG factors reached $2.78 trillion in the first quarter of 2022, up from less than $1 trillion two years earlier. The Proposed Amendments are intended to provide advisers and funds consistent standards for ESG disclosures, allowing investors to make more informed decisions as they compare various ESG investments. They also are designed to allow investors to determine whether a fund’s or adviser’s ESG marketing statements translate into concrete and specific measures taken to address ESG goals and portfolio allocation.

According to an SEC Fact Sheet, the Proposed Amendments would apply to registered investment companies, business development companies, registered investment advisers, and certain unregistered advisers. The Proposed Amendments would:

• Require additional specific disclosure requirements regarding ESG strategies in fund prospectuses, annual reports and adviser brochures
• Implement a layered, tabular disclosure approach for ESG funds to allow investors to compare ESG funds at a glance
• Require certain environmentally focused funds to disclose the greenhouse gas (GHG) emissions associated with their portfolio investments

Under the proposed layered approach, the type and amount of disclosure will depend on the type of fund. The Proposed Amendments identify three types of funds:

• Integration Funds integrate ESG factors alongside non-ESG factors in investment decisions. These funds would be required to describe how ESG factors are incorporated into their investment process.
• ESG-Focused Funds have ESG factors as a significant or main consideration in investment decisions. These funds would be required to provide detailed disclosure, including a standardized ESG strategy overview table.
• Impact Funds are a subset of ESG-Focused Funds that seek to achieve a particular ESG impact. These funds would be required to disclose how it measures progress on its objective.

A likely outcome of any enhanced disclosure requirements on ESG funds and advisers is that the investment funds and advisors will require enhanced disclosures and data from the companies they invest in. Together, with the SEC proposed Climate-Risk Disclosure Rules, the momentum on companies to collect, validate and compile data on GHG emissions and other environmental and social governance matters continues to build.

The proposed rule is open to public comment until 60 dates after it is published in the Federal Register.

The SEC press release can be found here.

A video of SEC Chairman Gary Gensler discussing the issue can be found here.

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