On May 25, 2022, the Securities and Exchange Commission (SEC) proposed amendments to the previously proposed rules governing environmental, societal, and governance (ESG) disclosures in annual reports and investor disclosures. These proposed amendments, which are currently undergoing notice and comment, have received over 200 comments since their release. Commenters range from asset managers to law firms to environmental lobbying groups. This blog post will examine the overall structure of the proposed legislation and review three different comments on the rule.

Overview of Legislation

This set of amendments set out to do three things:  

• Require that investors disclose what ESG factors they used to assemble their funds. The SEC hopes to differentiate between environmental, social, and governance decision-making. If ESG factors were used in creating the fund, the company must disclose them and explain the strategy behind their use.
• Provide insight into the strategy and performance metrics used to assess ESG funds. The SEC hopes to require companies to offer projections on their ESG performance, similar to how they provide financial projections. The SEC believes knowledge of a company’s goals allows for more informed investment decisions. 
• Require ESG-Focused funds to disclose greenhouse gas emissions associated with their investments. The SEC aims to require ESG funds to disclose the carbon footprint of their investments. The goal here is to produce comparable metrics regarding greenhouse gas emissions for investors. Notably, if funds opt not to factor greenhouse gas emissions into their ESG funds, they do not have to disclose greenhouse gas emissions.

Overall, this proposed legislation aims to prevent ESG-fund greenwashing, which is the practice of providing false or misleading information that the product is environmentally friendly. The SEC hopes that by standardizing the disclosures, they can provide more ESG-related information that will allow potential investors to make fully informed decisions. While this is a great goal, many key stakeholders have expressed concerns about the efficacy of the amendments. The amendments require that if ESG factors are considered in assembling the fund, the fund be subject to ESG disclosure. While this does increase information transparency, it may be misleading to investors who will assume a fund has heavily considered ESG factors when it may have been incidental to the goal of the fund, not the goal itself. Without clarification as to the extent ESG was considered in the fund’s assembly, investors are left guessing if a fund is labeled ESG intentionally or incidentally. The discussion below focuses on the concerns of many stakeholders regarding the proposed amendments.

Schulte Roth & Zabel LLP

Schulte Roth & Zabel (Schulte) is a full-service law firm that provides legal services to some of the world’s largest hedge funds and investment funds. Schulte’s comment on the proposed rule argues that standardized disclosure is essential but that the requirements are too broad, thus increasing confusion rather than providing clarity among investors. Schulte argues that most investors consider environmental, societal, and governance factors in any investment decision, regardless of whether it is for an ESG-specific fund. The proposed rule would thus label every strategy as ESG, rendering the term “ESG” meaningless. This would result in more greenwashing, creating confusion among investors about what is an ESG-based fund and what is not.

Furthermore, Schulte argues that the proposed rule does not distinguish between financial and non-financial ESG goals. The lack of guidance provides little information regarding non-financial ESG goals to investors, which may help drive decisions despite not being linked to a financial goal. Overall, Schulte supports the proposed rule, with a few amendments to make the overall language more precise so that the resulting disclosures do not confuse or mislead investors.

Franklin Templeton

Franklin Templeton (Franklin) is a global investment management organization. Franklin’s comment on the proposed rule supports the initial goals to provide investors with reliable, comparable, and material ESG disclosures. However, Franklin argues that the proposed rules are overly broad and place undue emphasis on decisions with ESG consequences, thus misleading investors in disclosure statements. Franklin expresses concern that by mandating extensive ESG strategy disclosure, investors may perceive the increased amount of ESG information to mean that ESG is a larger part of the deliberation process than it is. They say this would result in the very greenwashing of funds that the SEC is trying to avoid with this legislation. Therefore, they argue that funds subject to ESG disclosure should be redefined to only include funds with ESG as their primary goal rather than funds with incidental ESG factors.

Sierra Club

The Sierra Club is an environmental organization in the United States focused on political advocacy for environmental causes. The Sierra Club’s comment argues that asset managers have a fiduciary duty (a duty to act in a manner that benefits their clients) to be climate-aware in advising clients and that the proposed rules are good but do not go far enough to ensure this fiduciary duty is met. Specifically, the Sierra Club argues that the proposed rules do not go far enough to prevent greenwashing funds. They say that ESG marketing should be entirely prohibited for funds where ESG is not the fund’s primary goal and where the fund is not subject to a higher level of disclosure requirements. Finally, the Sierra Club argues that all asset managers, regardless of if they are ESG funds under the new proposed rule, should have to disclose ESG factors because of their fiduciary duty to disclose risks to their investors.

Conclusion

While law firms and investment managers seem aligned in their view that the rules are too broad and will confuse investors into thinking they are investing in ESG funds when they are not, the Sierra Club disagrees, arguing that these rules should be applied beyond ESG-based funds. All three groups, however, expressed concern that funds will be considered ESG-based funds when they are not truly ESG-minded. This can be prevented by adding additional clarification on ESG labeling in the final rule.