Securities and Exchange Commission
Proposed Rule Released May 25, 2022
Current Status of the Ruling:
Since the proposed ruling was released in May, the SEC has received input from the public, including the Bank Policy Institute in mid-June, which includes some of the largest banks (Goldman Sachs, Capital One, Bank of America, American Express, just to name a few).
The Bank Policy Institute’s comment letter asks the SEC to consider narrowing the reporting requirements, particularly related to transition risk (technology, regulatory, reputational, customer preferences, etc.) and for Scope 3 emissions (emissions resulting from activities from assets not owned or controlled by the reporting organization [basically, outside of their direct financial control, e.g. supply chain, investments, use of sold products, leased assets, employee commuting, business travel, etc.]): “The SEC should encourage Scope 3 emissions disclosures outside of the SEC reporting documents. Moving in that direction would encourage more robust climate risk disclosures at an appropriate pace as the quality and availability of information increases” (Bank Policy Institute).
The Bank Policy Institute also suggests that the SEC should require information to be disclosed in nonfinancial, not financial, statements. Read more about their response to the SEC proposed ruling in their comment letter.
We expect the SEC to provide an update later this summer after the public comment period is over – stay tuned!
Overarching goal: To create a consistent and comparable regulatory framework for ESG advisory services and investment companies.
Why is the SEC proposing this?
To inform and protect investors, allowing them to readily identify funds and advisors that do or do not consider ESG factors and determine how those factors are considered (see more in section, ‘why is the SEC proposing this’).
Who will this apply to?
Registered investment advisers, certain advisers that are exempt from registration, registered investment companies, and business development companies (see more in sections, ‘who will this apply to and ‘footnotes’).
What will be required by the SEC?
Additional, specific, minimum disclosure requirements in Annual Reports and other financial reporting documents regarding environmental, social, and governance (“ESG”) investment practices/ strategies (see more in section ‘what will be required by the SEC’).
I am pleased to support this proposal because, if adopted, it would establish disclosure requirements for funds and advisers that market themselves as having an ESG focus. ESG encompasses a wide variety of investments and strategies. I think investors should be able to drill down to see what’s under the hood of these strategies.”— Gary Gensler, SEC Chair, May 25, 2022
Why Is the SEC proposing this?
- The proposed rule and form amendments are designed to provide consistent standards for ESG disclosures, allowing investors to make more informed decisions as they compare various ESG investments.
- The proposal’s framework for ESG-related strategy disclosure is 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.
Who will this apply to?
- Does your company have “ESG-Focused Funds?”
- If yes, continue to the next question.
- If you’re not sure, review section ‘frequently asked questions’ for the definition of ESG-Focused Funds.
- If no, then this proposed rule is more of a signal that internal review should be made on any public-facing statements, especially related to environmental and social impact, if this is something your company will consider in the future.
- Does your company consider ESG factors in its investment strategies?
- If yes, continue to the next question.
- If you’re not sure, review sections ‘frequently asked questions’ and ‘footnotes’ for more information.
- If no, then this proposed rule is a signal that more and more investors and companies are starting to focus on ESG, so it might be a good time to evaluate if this is something your company should investigate further.
- How central are ESG factors to a specific fund’s strategy?
- If ESG factors are integrated alongside non-ESG factors in investment decisions, your company would be required to describe how ESG factors are incorporated into investment processes (in marking brochures, annual filings with the Commission, etc.) Read exactly how in Sections ‘what will be required by the SEC’ and ‘Frequently asked questions’.
- If ESG factors are a significant or main consideration, then your company would be required to provide detailed disclosure, including a standardized ESG strategy overview table.
- If your company has “impact funds” which seek to achieve a particular ESG impact, then your company would be required to disclose how it measures progress on its objective. Read more in Section ‘what will be required by the SEC’.
What will be required by the SEC?
The proposed amendments apply to rules and reporting forms for consistency and reliability in information for investors concerning the incorporation of ESG factors in funds and by advisors.
- Require additional specific disclosure requirements regarding ESG strategies to investors in fund registration statements, the management discussion of fund performance in fund annual reports, and adviser brochures.
- Require minimum disclosure requirements for any fund marketing itself as ESG-Focused and require streamlined disclosure for Integration Funds that consider ESG factors.
- Require ESG-Focused Funds to provide disclosures in their annual reports summarizing its progress on achieving its specific impact(s) in both qualitative and quantitative terms, and the key factors that materially affected the fund’s ability to achieve the impact(s).
- Require a fund for which proxy voting or other engagement with issuers is a significant means of implementing its strategy to disclose information regarding how it voted proxies relating to portfolio securities on ESG-related voting matters and information regarding its ESG engagement meetings.
- Require ESG-Focused Funds that consider environmental factors to disclose greenhouse gas emissions metrics, carbon footprint and the weighted average carbon intensity of their portfolio, for the portfolio in the funds’ annual reports. The proposed amendment requirement will focus on tracking and validating Scope 1 and 2 carbon emissions first, then outline a rolling timeline for Scope 3 disclosure requirements.
- Propose that funds tag ESG disclosures using the Inline eXtensible Business Reporting Language (“Inline XBRL”) structured data language.
- Propose an amendment to Form N-CEN and ADV Part 1 A applicable to all Index Funds, as defined in Form N-CEN, to provide identifying information about the index.
Frequently Asked Questions
To which funds and advisors does this apply?
Certain registered investment advisers, advisers exempt from registration, registered investment companies, and business development companies marketing themselves as ESG-Focused or as considering ESG factors.
What does ESG-Focused mean?
An “ESG-Focused Fund” would mean a fund that focuses on one or more ESG factors by using them as a significant or main consideration (1) in selecting investments or (2) in its engagement strategy with the companies in which it invests.
What types of ESG funds are impacted?
The SEC proposed utilizing a “layered” framework for disclosure requirements depending on how central ESG factors are to the fund’s strategy. Levels of disclosure range from a concise overview in the prospectus supplemented by more detailed information in other sections of the prospectus or in other disclosure documents to be reported in a structured data language (Inline XBRL).
- 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.
- 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: A subset of ESG-Focused Funds that seek to achieve a particular ESG impact would be required to disclose how it measures progress on its objective
Where will disclosures be required?
Funds and advisers will be required by the SEC to disclose in fund registration statements, the management discussion of fund performance in fund annual reports, adviser brochures, and a fund prospectus.
- Define ESG-Focused Fund
- An “ESG-Focused Fund” would mean a fund that focuses on one or more ESG factors by using them as a significant or main consideration (1) in selecting investments or (2) in its engagement strategy with the companies in which it invests.
- Any fund that has a name including terms indicating that the fund’s investment decisions incorporate one or more ESG factors and (ii) any fund whose advertisements or sales literature indicates that the fund’s investment decisions incorporate one or more ESG factors by using them as a significant or main consideration in selecting investments.
- A fund’s use of advertisements or sales literature that mention ESG factors, but not as a “significant or main consideration” in the fund’s investment or engagement strategy, would not alone cause the fund to be an ESG-Focused Fund
- Define registered investment advisers, certain advisers that are exempt from registration, registered investment companies, and business development companies
- Registered advisers & advisers exempt from registration SEC.gov | Information About Registered Investment Advisers and Exempt Reporting Advisers
- Registered investment companies SEC.gov | Investment Companies
- Business development companies SEC.gov | Business Development Company Report
- Define Inline XBRL https://www.sec.gov/structureddata/osd-inline-xbrl.html
- Define Form N-CEN https://www.sec.gov/files/formn-cen.pdf
- SEC Rule https://www.sec.gov/rules/proposed/2022/33-11068.pdf