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After the U.S. Securities and Exchange Commission (SEC) proposed mandatory climate disclosures in March 2022,it has now pushed forward with another set of proposed disclosures, this time focusing on ESG investment products. According to the proposal, funds marketed as ESG will be required to demonstrate the related information that qualify them as an ESG product.
The move aims to improve transparency on ESG disclosures, inline with its mission to protect investors and aid them in decision-making, as well as to control greenwashing in an industry where ESG is the hottestcurrency of the moment.
The proposal outlines three types of funds for which different degrees of disclosure requirements apply:
• ESG-integrated fund: ESG is one factor among others that affect decision-making. ESG-integrated funds must explain what factors are considered and the strategy used, such as the type of assets that are included or excluded, thematic design, and any specific objectives or targeted impacts.
• ESG-focused fund: ESG factors are a major consideration. This can include exclusionary or inclusionary screenings, ESG index tracking, oriented towards achieving one or more ESG impacts, proxy voting or engagement on ESG factors, and other actions. ESG-focused funds need to disclose the criteria and data used in evaluations, as well as detailed strategies on meeting targets.
• Impact fund: The objective is to achieve one or more ESG impacts. Impact funds have to disclose metrics and KPIs for the fund’s objective as well as the time horizon for achieving the KPIs. It is also important for impact funds to disclose the connection between the ESG impact desired and financial returns.
While the disclosure requirements vary for each fund, all are required to disclose information on their ESG strategy including how ESG factors are part of the investment process. This could be screening criteria used, the percentage of the fund that is screened for ESG, use of internal or external data and methodologies, and any frameworks and indices referenced. Another disclosure required is how the fund conducts proxy voting or engages with companies on ESG matters. This should include the number of engagement sessions and number or percentage of issuers engaged on ESG. For environment-oriented ESG funds, carbon footprint metrics are required.
Highly specific rules also apply to the naming of funds - only funds with 80% or more assets aligned to an ESG investment strategy can use ‘ESG’ in the fund name. So funds that have a minority of ESG assets will find it more difficult to explicitly market themselves as such. It is however unspecified if they would be allowed to use other close terms such as ‘sustainable’ and ‘green’.
The new rules are aimed at preventing misleading claims all the way to outright greenwashing. Given the specific requirements on proxy and engagement-related disclosures, companies should adopt good ESG practices that reduce the chances of greenwashing. They should avoid proxy washing and engagement washing by strengthening institutional and governance processes. It will also be necessary to understand how to calculate carbon footprint as per the rules’ preferred metrics and weighted average carbon intensity (WACI) and potentially Scope 3 emissions. Overall, funds need to have a good grasp of the ESG data and metrics that influence their decision-making process, and understand how those metrics lead to investor profit.
As it stands, ESG funds are relatively new in the investment space and the appropriate regulations to govern associated risks are developing in tandem with the growth of these funds. The SEC’s proposed rules can be aguiding document for funds seeking to prove that their ESG strategy goes more than skin deep.
• We explain the SEC’s ESG disclosure rules and help you understand what data you need to collect to satisfy requirements.
• We simplify the collection of ESG data in your organisation by offering one central platform and integrations into ERP, HRM,CRM, EMS etc., to automate data collection.
• We facilitate data collection from your suppliers and ensure that relevant information such as Scope 3 emissions from your supply chain arrives in a complete and accurate manner. We will handle theburden of information exchange with your suppliers.
• We help you complete the information requests from regulators and guarantee the protection of business-critical information, for example about your supplier network.