The game is in the name of the game−and the name of the game is ESG: SEC proposes new Fund rules to further combat “Greenwashing”

Continuing its focus on ESG practices within the fund industry, the Securities and Exchange Commission released proposed rules on May 25, 2022, that are intended to allow investors to readily discern whether a fund is focused on an ESG strategy and, if so focused, what the fund’s goals are and how it is progressing toward such goals.

The Proposed Naming Rules

Under the current naming rule, Rule 35d-1, if a registered investment company’s name suggests it has a focus on particular investment types, industries, or geographies, or that it has tax-exempt status, then such a fund must adopt a policy to invest at least 80% of the value of its assets consistent with its name.  The naming rule, proposed to apply to business development companies as well as registered investment companies, recognizes that while investors should review a fund’s disclosures, a fund’s name can be a significant factor in an investor’s investment decision.

The SEC’s proposal will expand the naming rule to do four things:

1.  Expand the 80% requirement to apply to funds whose names suggest they invest in issuers or investments with particular characteristics such as ESG themes.
2. The proposal will require funds whose assets fall below the 80% requirement to come back into compliance within 30 days.
3. The proposal will require a fund to disclose how it defines the terms in its name and selects investments reflective of its name.  Funds will have to report on Form N-PORT that their investments fulfill the 80% requirement.
4. Funds investing in derivatives will be required to use the notional amount of the derivatives and not the market value of the derivatives in determining compliance with the 80% requirement.

The proposal notes that funds that consider ESG factors along with other factors without giving greater significance to the ESG factors will not be able to use ESG terms in their fund names.

The Proposed ESG Disclosure Rules

In a separate release, the SEC is also proposing new rules regarding the disclosure of ESG information for registered investment companies, business development companies, registered investment advisers, and certain unregistered advisers in order to promote both comparability and reliability of ESG information.

Funds that consider ESG factors in making investment decisions will be required to disclose additional information.  The level of such additional information will depend upon the type of fund.  The proposed rule identifies three types of funds:

Integration Funds – These are funds that integrate ESG factors alongside non-ESG factors in investment decisions.  Integration funds will be required to describe how ESG factors are incorporated into their investment process.

ESG-Focused Funds – These are funds that give significant consideration to ESG factors.  ESG-focused funds will be required to provide detailed disclosures, including a strategy overview table.

Impact Funds – These are funds that are ESG-Focused funds that seek to achieve a particular ESG impact.  Impact funds will be required to disclose how they measure progress toward their objective.

Advisers who consider ESG factors will be required to make disclosures in their brochures regarding their consideration of ESG factors in their investment strategies and report certain ESG information in their annual filings with the SEC.

ESG-Focused funds that use proxy voting or engagement with issuers as a means of implementing their ESG strategy will be required to disclose their proxy voting and issuer engagement.

ESG-Focused funds that consider environmental factors will be required to disclose their carbon footprint and the carbon intensity of their investment portfolio.  The SEC stated that these disclosures are intended to allow investors to compare greenhouse gas emissions between funds or other investments.  Funds that do not consider greenhouse gas emissions will not be required to provide such disclosures.

If an Integration fund considers greenhouse gas emissions, then the Integration fund would be required to disclose how the fund considers such emissions and the methodology and data sources considered by the fund.

Next Steps

Both rules are now set to go through the required public notice and comment process before being enacted.  The comment period for each proposed rule will end 60 days after the proposed rule is published in the Federal Register.