New SEC Disclosure and Reporting Requirements Regarding ESG

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Many investment funds, advisers and companies are working to integrate environmental, social and governance (ESG) factors into their investment practices, but the United States Securities and Exchange Commission (SEC) has proposed to new disclosure and reporting requirements that will impose a disclosure framework to demonstrate “concrete and specific steps taken to achieve ESG objectives and portfolio allocation”.

Many investment funds, advisers and companies are working to integrate environmental, social and governance (ESG) factors into their investment practices, but the United States Securities and Exchange Commission (SEC) has proposed to new disclosure and reporting requirements that will impose a disclosure framework to demonstrate “concrete and specific steps taken to achieve ESG objectives and portfolio allocation”.[1] The SEC appears to be taking steps not only to combat the practice of “greenwashing”, but also to ensure that companies provide investors with consistent, comparable and reliable information. The proposed requirements would apply to registered investment advisers, registered investment companies, business development companies and certain advisers that are exempt from registration but still use ESG factors in their investment strategies.

In addition to the proposed reporting requirements, another proposed rule would expand the scope of the names rule, requiring funds whose names suggest an ESG orientation, or a “growth” and “value” orientation, to invest at least 80% of the value of their capital. assets in line with the orientation suggested by its name.[2] Investment entities have the opportunity to demonstrate their comparative methodological advantages in this growing and influential investment space by providing investors with consistent, comparable and reliable information.

These proposed rules are not the SEC’s first effort to prioritize ESG. The SEC has created a Climate and ESG Task Force, seeking to “identify any material deficiencies or inaccuracies in issuers’ disclosure of climate risks” as well as “disclosure and compliance issues related to companies’ ESG strategies.” investment advisers and funds”.[3] In early 2022, the Task Force initiated an ESG-related enforcement action for “inaccuracies and omissions” regarding ESG, which was settled for $1.5 million. The proposed rules could give the SEC additional tools to promote transparency and truth in ESG-focused investing.

The SEC hopes to thread the needle to provide investors with comprehensive information in predictable places without overwhelming or misleading investors by requiring detailed information too soon in documents such as prospectuses. According to the SEC, the proposed rules envision a “layered disclosure” framework that could promote disclosure that is “inviting and usable by a wide range of investors.” For example, the SEC explained that a fund would disclose that it considers greenhouse gas (GHG) emissions as one of several ESG factors in its simplified prospectus, along with the exact methodology of how it considers GHG emissions detailed later in the legal prospectus. The SEC hopes that the “current lack of consistent, comparable and decision-useful data” regarding GHG-related claims will be remedied by these new rules.

Private sector efforts, such as the ESG Data Convergence Project formed to standardize ESG disclosures, can bring clarity to the SEC’s approach.[4] The SEC does not seek to define ESG or related terms in the proposed investment disclosure rules and names of investment companies, which could subject the proposals to criticism for their vagueness.

According to the SEC, disclosures can make it easier for investors to identify and compare ESG-focused funds. The proposed rules require funds to adhere to investor-specific ESG disclosure requirements in fund registration statements, fund annual reports and advisor brochures.[5] The level of detail required depends on “the extent to which a fund takes ESG factors into account in its investment process”.[6] The rules contemplate three broad categories of ESG investment approaches:[7] (1) Opportunities Fund,[8] (2) ESG-focused funds,[9] and (3) Impact Fund.[10]

  • If finalized, the proposed rule requires integration funds to briefly summarize how a fund integrates ESG factors into its investment selection process, including the ESG factors considered by the fund. Integration funds should also be aware that fund names that include language indicating that their investment decisions “incorporate one or more ESG factors” could be considered “substantially misleading or misleading” under the Proposed Names Rule. .

  • ESG-focused funds, such as a fund applying an exclusion filter, should disclose, in tabular, machine-readable data, an overview of the fund’s strategy, how the fund integrates the factors ESG in its investment decisions and how the fund votes proxies and/or engages with companies on ESG issues.

  • Finally, impact funds should summarize “the progress made in achieving their specific impact(s) in qualitative and quantitative terms, and the key factors that materially impacted the ability of the fund achieve the impact(s), on an annual basis”.

Although the rules are yet to be finalized, the proposed requirements appear to be in line with the SEC’s climate-related disclosure rule and as a result registered funds may need to significantly improve and increase their ESG-related disclosures.

The SEC invites the public to comment on the proposed rules for a period of sixty days after the effective date, which is when the rules are published in the Federal Register. Compliance with the vast majority of the proposed disclosure and regulatory reporting requirements would be required one year after the effective date, while disclosure to shareholders would be required 18 months after the effective date. The investment company name requirements would have a compliance period of one year from the effective date.

Additional research and writing by Kevin Cassato, 2022 Summer Associate in ArentFox Schiff’s Chicago office and law student at the University of Illinois School of Law.



NOTES

[1] See Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices, Advisers Act Release No. 6,034; Investment Company Act Release No. 34.594 (proposed May 25, 2022) (to be codified at 17 CFR pt. 200, 230, 232, 239, 249, 274 and 279) (“Enhanced Disclosures”).

[2] See Investment Company Names, Investment Company Act Release No. 34.593 (proposed May 25, 2022) (to be codified at 17 CFR pts. 232, 270 and 274) (“Investment Company Names”).

[3] Press release, Sec. & Scale Comm’n, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (March 4, 2021).

[4] The private equity industry’s first-ever ESG data convergence project announces milestone engagement of over 100 LPs and GPs, Carlyle (January 28, 2022).

[5] Specifically, forms N-1A, N-2, N-CSR, N-8B-2, S-6, N-CEN and ADV Part 2A will be modified. Identifier. to 20, n. 37.

[6] Identifier. at 23 years old.

[7] Unit Investment Trusts (UIT) are also subject to certain limited requirements, namely explaining how ESG factors were used to select portfolio securities if such factors were taken into account. See id. at age 67.

[8] An integration fund is a “fund that takes into account one or more ESG factors as well as other non-ESG factors in its investment decisions, but these ESG factors are generally not more important than other factors in the investment selection process, so ESG factors may not be decisive in the decision to include or exclude a particular investment in the portfolio. » Identifier. at 26 years old.

[9] An ESG-focused fund is a “fund that focuses on one or more ESG factors by using them as an important or primary consideration (1) in the selection of investments or (2) in its strategy for engaging with companies in which he invests. Identifier. at 33 years old.

[10] An impact fund is an ESG-focused fund that “seeks to achieve one or more specific ESG impacts,” such as a fund whose stated purpose is to finance the construction of affordable housing. . . .” Identifier. at 35 years old.

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