Socially responsible investing (SRI) has taken the investment world by storm. More and more retail, institutional, endowments, and pension funds have begun seriously integrating environmental, social, and governance (ESG) factors into their investment decisions. With assets and demand surging, Wall Street has continued to launch more and more products designed to tap into ESG, while companies have started to tout their ESG efforts.
The only problem is some of these investment products and claims, well, aren’t exactly too green.
The media has dubbed this ‘greenwashing’ and the SEC is taking a note of it. To avoid confusion and investor fraud/mistrust, the SEC has recently started to tackle greenwashing in a major way. New proposals, rules, and even damages are starting to be revealed. In the end, it’s a good thing for investors.
Be sure to check out our ESG Channel to learn more.
The Rise of ESG & Greenwashing
$35 trillion. That’s a staggering sum. And it just so happens it’s the total number of assets in ESG/SRI-related funds and investment vehicles at the end of 2020, according to trade group Global Sustainable Investment Association. Given the projects and continued asset gathering, Bloomberg now predicts that ESG assets will top $50 trillion by the end of 2025 and become roughly one-third of all assets under management globally.
That’s some serious coin and underscores the popularity of the movement and using various ESG factors in portfolio construction. However, ESG is a hard nut to crack and there’s a lot of flimflammery that’s going on below the surface.
For example, when investors buy an intermediate bond fund, you know that you’re getting bonds within a certain duration and with certain credit ratings. ESG is sort of a minefield, with no set rules of what constitutes ESG. For every real ESG fund, there’s a couple that may not fit the ideal definition. A recent study, by shareholder advocacy group As You Sow, showed that 60 of the largest ESG funds “failed to adhere closely to the principles of environmental, social and governance investing.”
The media and pundits have dubbed this phenomenon ‘greenwashing.’ Basically, greenwashing occurs when a firm puts on the air of adhering to ESG principles without actually doing so. It’s slapping an ESG label/mandate on a poorly performing existing fund to gather assets without actually changing it. It’s lying about future carbon initiatives without the intention of doing so.
And with ESG demand/adoption growing, greenwashing is quickly becoming an issue.
The SEC Comes to the Rescue
Under Chairman Gary Gensler’s ‘retail investors first’ doctrine, the SEC is starting to take a hard look at greenwashing, ESG, and investor protection. To that end, the agency proposed a series of new rules designed to stamp out greenwashing and ensure investors get what they signed up for: the Names Rule and ESG Disclosure Rule.
The ESG Names Rule, which amends Rule 35d-1 under the Investment Company Act of 1940, will require that only funds with an ESG purpose be permitted to label themselves as such. Under the amendment, a fund must invest 80% of their assets in line with their names and investment policies to call themselves a certain kind of fund. This increases the asset requirement for naming and technically applies to all funds, not just ESG.
Secondly, the Disclosure Rule deals with how funds are marketed to advisors and investors. The rule identifies three categories of ESG funds:
- Integration Funds
- ESG-Focused Funds
- Impact Funds
Investment managers must fully disclose how they use ESG in their investment decisions, what/how various benchmarks are determined, and what level of ESG commitment the fund has.
So, a fund manager that only uses ESG as a piece of their recipe, but not as the main ingredient, might not be able to call themselves an ESG fund under the new rules. Ultimately, the proposals are designed to limit investor fraud and help them understand exactly what they are getting.
And the SEC seems serious about fighting greenwashing on the enforcement front as well. Recently, the agency fined Bank of New York Mellon and its investment unit after it falsely stated that some of its mutual funds had conducted ESG quality reviews. The regulatory authority has also begun investigating Goldman Sachs for similar claims.
Be sure to check our Portfolio Management Channel to learn more about different portfolio rebalancing strategies.
A Major Step Forward for ESG
In the end, greenwashing remains a major issue and confusion abounds in the ESG. Some market pundits have called it the wild west of the investment world. With the new proposals and recent enforcement actions, the SEC hopes to reign in some of the misconceptions with regard to ESG, streamline definitions, and ultimately create a safe space for investors large and small.
With that, ESG could have the ability to not only grow further but stronger as well, with investors buying and asset managers correctly designing products for their needs and portfolios.
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