The Securities and Exchange Commission has taken another step towards heightened climate transparency with two new proposals covering how US investment firms label and market funds for environmental, social, and governance (ESG)—asking that stronger ESG claims be matched with emissions data to prove that high-carbon assets aren’t being greenwashed.
In this guide we cover to whom these proposals apply, what they ask for specifically, how they fit with similar proposals in the EU/UK, and why and how to act ahead of them.
Which firms are affected by these proposals?
Any investment company or advisor currently required by the SEC to file one of the following forms: N-1A, N-2, N-CSR, N8B-2, S-6, N-CEN, or ADV Part 2A.
This covers most registered investment funds and some investment advisors.
What do the proposals ask for?
The first proposal covers fund categorization. The core idea: the more central that ESG is to the objectives of the fund, the stronger the disclosure requirements should be. To make this explicit for investors, the SEC wants funds to identify as one of three distinct tiers:
- ESG-integrated funds, where ESG qualities are a routine selection factor, but only as one factor among many.
- If ESG is a consideration, the fund needs to disclose its methodologies and data sources used in their evaluation. Funds will then be accountable to either consistently evaluate accordingly or remove the ESG labeling.
- ESG-focused funds, where ESG qualities are a “significant” or “main” consideration.
- Funds that don’t consider greenhouse gas emissions will need to say so explicitly in a prominent place in their disclosures.
- Funds that do consider emissions will need to disclose both their total carbon footprints (mostly Scopes 1 and 2; see later section on Scope 3) and weighted average carbon intensities (emissions divided by a business metric like revenue) across their portfolios, with any offsets left out. They’ll also need to outline their methodologies for including and excluding assets, along with any relevant information on how they’ve voted on ESG-related proxies.
- A summary of all this information will also need to be published in a standardized table to allow for easy comparison, with links in that table to fuller explanations, e.g.:
|Does this fund…||Yes||No||Link to details|
|Incorporate ESG factors||✓||[link to your relevant content]|
|Screen to excludes non-ESG assets||✓||[link to your relevant content]|
|Screen to include ESG assets||✓||[link to your relevant content]|
|Seek to achieve a specific impact||✓|
|Vote proxies on ESG issues||✓|
|Engage on ESG issues||✓|
- Impact-focused funds, where specific ESG outcomes are the explicit intent of the funds. They’ll need to disclose how they measure qualitative and quantitative progress towards those objectives—including relevant emissions data for any environmental goals.
The second proposal covers fund naming. The SEC wants to extend the 1940 “Names Rule” to cover ESG labeling, where any fund that includes a specific type of investment in its name (like ESG) would need to allocate at least 80% of the fund’s value accordingly—which for ESG would also require a clear definition of the criteria used.
Under both proposals, these disclosures would need to be included in all fund prospectuses, annual reports, and advisor brochures.
How does this relate to similar rules in the EU/UK?
The US is catching up with the UK and the EU. These proposals are the equivalent of Sustainable Finance Disclosure Regulation (SFDR) in the EU and parts of the Sustainability Disclosure Requirements (SDR) regime in the UK. See our primer on those programs for more.
The major difference is that the US still lacks a vital piece of the puzzle: a formal taxonomy that defines which economic activities are officially “green”—in the form of specific carbon-intensity benchmarks that activities must fall below to qualify. Unless the US develops its own taxonomy, it will remain up to each investor to grade emissions using their own values.
What about Scope 3 emissions?
Scope 3 emissions, which happen elsewhere in a company’s value chain (mostly with suppliers), typically make up 80% or more of their total footprint. While excluding this data gives a very incomplete emissions picture, the SEC will only require funds to include Scope 3 data for portfolio companies that have already measured and publicly shared this data themselves.
Requirements aside, more companies are voluntarily measuring and reporting their Scope 3 data every day, knowing that it’s the best way to identify carbon hot spots and meaningfully reduce emissions. Asset managers can accelerate decarbonization of their portfolios by commissioning measurements for any companies that haven’t done so yet.
Do these disclosures need to be audited first?
While neither proposal calls for any new auditing component, accuracy issues on most disclosure forms are already subject to SEC review.
What are the next steps for these proposals?
The SEC has signaled that it will adopt the new rules in October 2023. The October target date was communicated through the Fall 2022 Regulatory Flexibility Agenda, which sets out the SEC’s regulatory priorities in 2023. The October deadline is indicative and not definite - there may be further delays to the publication of the final rule, but October is now the reasonable planning assumption.
When should companies begin preparing?
Though the first date to comply with the rules won’t be before late 2024, the SEC and other global regulators are taking strong interim action on misstated or omitted ESG-related information. These proposals aren’t just about future rules: they’re active guidance on how firms and advisors should act today to ensure that their ESG funds are onside of the SEC’s current expectations.
To ensure compliance, reduce liability, and accelerate decarbonization, funds can use tools like Watershed Finance to quickly measure and understand Scope-1-3 emissions for all portfolio companies. If we can help, please get in touch.