Morningstar calls for elimination of ‘ESG-Integration’ label in SEC consultation response

Category could contribute to greenwashing, warns financial services giant in response to watchdog’s proposed disclosure rule for investment firms.

Morningstar has called on the US Securities and Exchange Commission (SEC) to “eliminate” the ESG-Integration category from its proposed disclosure rule for investment firms and advisors, warning that it could “contribute to greenwashing”.  

The US financial services giant, which owns ESG data provider Sustainalytics, was responding to the financial regulator’s consultation on its proposed rule, titled “Environmental, Social, and Governance Disclosures for Investment Advisers and Investment Companies”. 

That consultation, along with another on the rules around fund names, including ESG-labelled ones, closed yesterday. 

The SEC’s 362-page proposal seeks to establish standardised disclosures to ensure registered funds are not “appearing to be something that they’re not”, SEC staffer Jessica Wachter said in May as the rule was approved by the regulator’s commissioners.

Under the rule, advisers would have to describe their use of ESG factors, their strategies and methods of analysis, and how they voted relevant proxies.  

Depth of disclosure would depend on the centrality of ESG to strategies, with three categories being floated: ESG-Integration (in which ESG plays a smaller part); ESG-focused (rely on one or more ESG factors); and ESG- Impact (designed to achieve a certain ESG goal). 

Morningstar wrote in its 34-page submission that requiring a fund to disclose whether it considers ESG “not informative for investors”. It added that the ESG-Integration label would “include too many funds using too little ESG to be meaningful”.  

“At most, these funds should disclose simply that ESG is a supporting consideration, but mandating further disclosure is not beneficial,” the Chicago-based firm stated. 

It added that disclosure may even be harmful. “Under the proposed rule, greenwashing may worsen, as funds that do not necessarily consider themselves to ‘integrate’ ESG factors may nonetheless be required to disclose such considerations as if they do.” To avoid these risks, Morningstar recommends that the SEC drop the ESG-Integration category altogether.  

The firm shared analysis which showed that, of 2,600 active equity open-end funds, almost 17 percent use the term ESG in their summary prospectuses and would need to disclose under the ESG-Integration category.  

“[As ESG] statements grow more common in fund prospectuses, the ESG-Integration category will be far too large to be helpful for investors trying to ascertain a fund’s level of commitment to ESG,” it added.  

Morningstar also highlighted that the SEC’s use of the term ESG-Integration is not synonymous with how it is used elsewhere. It pointed to the definition used by the UN-supported Principles for Responsible Investing (PRI), which categorises it as “the explicit and systematic inclusion of ESG issues in investment analysis and investment decisions”.  

Under the SEC’s proposal, integration applies to strategies that “consider one or more ESG factors alongside other, non-ESG factors in investment decisions”. In such strategies, the financial watchdog added, “ESG factors may be considered in the investment selection process but are generally not dispositive compared to other factors”. 

Morningstar recommended that the SEC remove the integration category and limit ESG disclosure requirements to ESG-Focused funds, including impact ones. But, it added, if the regulator wishes to create a label for funds for which “ESG factors play an insignificant role”, the term “ESG Consideration Fund” would be more accurate.  

Morningstar’s response was penned by Jon Hale, head of sustainability research; Aron Szapiro, head of retirement studies and public policy; and Jasmin Sethi, associate director of policy research.