Investors have a couple of months to respond to the latest request for comment from the SEC regarding the Commission’s Names Rule; an investor protection measure designed to help ensure that investors are not misled or deceived by a fund’s name.
The request for comment on the Rule has a clear focus on the clarity of ESG-related investment products.
The Names Rule requires that “if a fund’s name suggests a particular type of investment, industry or geographic focus the fund must invest at least 80 percent of its assets in the type of investment, industry, country, or geographic region suggested by its name”.
The request for comment asks a number of questions, such as: Are fund names marketing exercises? Is the rule effective in preventing deceptive practices? Should the rule be repealed? Is the 80% threshold correct or should it be lowered?
The Names Rule does not apply to “the use of terms that suggest an investment strategy (such as “growth” or “value”), rather than a type of investment”, says the SEC. This is a distinction that few investors are aware of, says Julie Gorte, senior vice president at Impax Asset Management, adviser to sustainable investor Pax World Funds.
"An engagement fund might choose to invest in sustainability laggards specifically to make progress. But that fund would likely be prohibited from using sustainability-themed titles under the Names Rule…" – Julie Gorte
The SEC adds that Staff “has observed that some funds appear to treat terms such as ‘ESG’ as an investment strategy (to which the Names Rule does not apply) and accordingly do not impose an 80 percent investment policy, while others appear to treat ‘ESG’ as a type of investment (which is subject to the Names Rule)”.
The example suggests the potential intent of the request for comment.
Apart from a discussion of derivatives and how they might be referred to in a name, ESG-naming is the main focus of the request.
Of the many questions it asks, most are ESG-related. They include: “Are investors relying on these [ESG] terms as indications of the types of assets in which a fund invests or does not invest (e.g., investing only in companies that are carbon neutral, or not investing in oil and gas companies or companies that provide substantial services to oil and gas companies)?”
Or, it asks, do investors understand these terms as indications of a strategy, such as “investing with the objective of bringing value-enhancing governance”, or investing with objectives that include “non-economic objectives”? If a fund calls itself ESG, must it select investments that satisfy all three factors?
Finally, it says “should we instead require funds using these terms to explain to investors what they mean by the use of these terms?”
Sanford Lewis, Strategic Counsel, who advises many activist investors, told RI: “It could be beneficial to establish some clarity about the meaning of ESG. But the problem is that in the current regulatory environment the Commission is not doing what’s needed to ensure standardisation of ESG-related disclosure, which would be a more supportive way to go than establishing new restrictive regulations on ESG investors.”
Julie Goodridge, CEO of NorthStar Asset Management agreed and disagreed at the same time. “The problem is that no one has defined what ESG means. And it changes depending on who is doing it; because of that it is best seen as a strategy. It’s so obscure at this point that anyone can hang out a shingle and say: ‘we’re not going to invest in fossil fuels so we’re all about ESG’. Until someone defines the language you can’t say whether the Names Rule even applies.”
Asked who would best define the language, Goodridge said that the members of US SIF [The Forum for Sustainable and Responsible Investment] should be the ones to be asked, the ones who “have been doing it for years”. She noted that when she was elected to the board of US SIF, her number one requirement was for every member to be able to define what they meant by SRI [socially responsible investing]. “That’s also what the SEC cares about,” she said.
"There’s probably a group of senior people with a bug in their ear sitting around thinking up something that will gum up the works; let's come up with 50 things that could create challenges for people doing sensible and important things." – Cary Krosinsky
Impax’s Gorte added: “The SEC is raising a legitimate question, especially with the recent surge in interest in sustainable investments. It seems unlikely, however, that answering the questions posed in this release will contribute significantly to reducing any confusion over what sustainable investing is, or the degree to which any specific fund conforms to the objective of sustainability.”
“There are also many ways to pursue sustainability,” she continued. “Some funds say they invest in sustainability leaders; some avoid specific types of investments (e.g., energy companies); some focus on engagement. An engagement fund might choose to invest in sustainability laggards specifically to make progress. But that fund would likely be prohibited from using sustainability-themed titles under the Names Rule in the same way that a fund that does nothing to align the portfolio to sustainability measures, or engage with portfolio companies to make them more sustainable.”
It is likely that most investors would want such an engagement fund to have ‘sustainability’ in its name.
Andrew Behar, CEO of shareholder advisory group, As You Sow, noted that the EU had already established naming conventions created by a group after the Paris Climate Summit which said that if you had ‘fossil fuel free’ in your name, you had better be fossil fuel free.
He points to a selection of funds that ‘broke’ those rules. The SPDR MSCI EAFE Fossil Fuel Free ETF holds 26 fossil fuel companies, for example, and the SPDR S&P 500 Fossil Fuel Reserves Free ETF holds 39 fossil fuel companies, six of which have reserves, he told RI. “Vanguard prominently represents to investors and potential investors that its ESG US Stock ETF specifically excludes stocks of companies in the following industries: adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling, and nuclear power. But Vanguard currently holds nearly 3% of its assets across 68 fossil-fuel stocks in the oil and gas industry and fossil-fired utilities.”
Cary Krosinsky, lecturer and co-founder of Real Impact Tracker, which highlights the impact fund managers have on ESG, was scathing: “If I was an SEC commissioner I would be hammering a name like Fossil Fuel Free hard, because what’s your criteria to say something is fossil fuel free? Fossil fuel is in just about everything.”
Krosinsky was sceptical of the SEC effort, however: “Asia is half the world economy and there is no ESG data available there really, so, anybody who’s trying to run a sustainable fund invested in Asian companies, it would be impossible for the SEC to prove they were or were not breaking the Names Rule.”
He also warned of other, more serious consequences: “Is the SEC in the business of making sustainable finance less competitive for US managers versus those based in the rest of the world?” he asked. “If this goes on you may see business going to Europe, which might not be a bad thing in general, but it would make US firms and ultimately the US itself less competitive.”
Gorte added: “We recognize that the EU is trying very hard to establish a new taxonomy governing sustainable finance. While the effort is likely to come up with some useful insights, it is virtually certain that any effort to distinguish specific securities as green or not green will be unfair to many issuers. In reality, and in science, the gradient between sustainable and unsustainable is a continuum, and any choice that makes that continuum essentially binary is arbitrary.”
Likening this latest SEC initiative to all the others that seem to be undermining shareholders and bolstering the power of corporations, Krosinsky went further: “These things seem to come out, whether it’s Main Street Investors or whatever, and they don’t seem particularly well thought out. The most likely scenario here is you have some kind of conservative think tank that hired some students to go out and cobble something together that is not well crafted and they try to get people of influence to pay attention, and that's the repeating pattern. There’s probably a group of senior people with a bug in their ear sitting around thinking up something that will gum up the works; let's come up with 50 things that could create challenges for people doing sensible and important things.”
Impax’s Gorte summed up: “Making a choice as to whether a specific investment meets anyone’s sustainability criteria is something the SEC can’t solve. That’s the individual’s judgement, not the SEC’s.”