(Article from Registered Funds Regulatory Update, July 2022)
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The SEC voted to propose new ESG disclosure requirements for investment companies and investment advisers. The proposal would require funds and advisers that consider ESG factors in their investment processes to disclose additional information about their ESG analyses and activities. The amount and specificity of the required disclosure depends on the extent to which a fund considers the weight given to the ESG factors in its investment process.
Funds: The proposal categorizes ESG funds into three buckets:
- Integration Funds – Funds that integrate ESG factors alongside non-ESG factors in investment decisions would be required to describe how ESG factors are incorporated into their investment process. The proposal omits any materiality threshold for integration funds, indicating that any fund that considers one or more ESG factors alongside other non-ESG factors in investment decisions would qualify as an ESG fund. Taken to its extreme, a fund that considers thousands of investment signals, a handful of which relate to “E”, “S” or “G” factors, would fall within the ambit of the Integration Fund regulation.
- ESG-focused funds – Funds for which ESG factors are a significant or main consideration would be required to provide detailed disclosure, including a standardized ESG strategy overview table.
- Impact funds – ESG-focused funds that seek to achieve a particular impact would be required to disclose how they measure progress on their objectives, including information about proxy voting and issuer engagement, as applicable.
These categories appear to be designed to be consistent with the fund categorization called for by the Financing for Sustainable Development, and the proposal imposes specific disclosure requirements for each category.
Advisers: Advisers that consider ESG factors would be required to make generally similar disclosures in their brochures describing any ESG criteria or methodologies used in their investment strategies, including details about the adviser’s use of any internal methodologies, external providers or frameworks, inclusionary or exclusionary screens, or indices. As with funds, advisers that seek a specific ESG impact must describe any progress toward the stated impact.
Green House Gas Emissions Reporting: Likely the most controversial aspect of the proposal is a new framework for climate-related disclosures by registered funds. The proposed framework builds on the SEC’s March 2022 rule proposal to establish a new framework for climate-related disclosures for public company issuers. The fund proposal would require ESG-focused funds that consider environmental factors in their investment process to report both the carbon footprint and the weighted average carbon intensity of their portfolio, which the proposal sets forth a detailed methodology for calculating. Because much of the data that supports the calculations is not publicly available or reliable, a fund may use a good faith estimate of a portfolio company’s emissions if it is unable to identify publicly available information after a reasonable search. If a fund uses a good faith estimate, it must describe how it calculated the estimate and the sources of data underlying the calculation. Due to the scarcity of existing data, it appears that the proposal could result in funds with similar portfolios reporting different results. The burden of these reporting requirements are also likely to have a chilling effect on the use of ESG-focused investment strategies by registered funds.
Comments on the proposed requirements are due on August 16, 2022.
Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices, SEC Rel. No. IA-6034 (May 25, 2022), available at: https://www.sec.gov/rules/proposed/2022/ia-6034.pdf.