PRI warns SEC that ESG disclosure rule could be seen as marketing tool

RI looks at responses to financial watchdog’s proposed rule, including pushback from influential fund bodies and managers.

The UN-supported Principles for Responsible Investment has warned the US Securities and Exchange Commission that its proposed ESG disclosure rule could be viewed as a “marketing” tool by investment firms and advisers subject to it. 

Responding to the financial regulator’s consultation, which closed on Wednesday, the investor body wrote: “We caution the Commission that market participants may view the proposed rule as a labelling – and thus, a marketing – regime.” It urged the powerful watchdog to “consider this likelihood and potential impacts when finalising the proposal”. 

To mitigate this risk, the PRI recommended that the final rule “should provide market participants with as much clarity as possible on the proposed categories and whether they can and should be understood as sustainability or ESG-related labels or not”. 

The SEC’s proposal, titled “Environmental, Social, and Governance Disclosures for Investment Advisers and Investment Companies”, seeks to establish a standardised disclosure regime to ensure registered funds are not greenwashing. 

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). 

The EU’s anti-greenwashing Sustainable Finance Disclosures Regulation is cited by the PRI as an example of how the market can take a disclosure regime and make it a labelling one.

SFDR was designed to prescribe what level of disclosure a fund with ESG aspirations was required to make but does not set out which types of products belong under which categories.  

In June, Europe’s sustainable investment body Eurosif warned that the ambiguity of current SFDR product categories “may expose FMPs [financial markets participants] to allegations of mis-selling if clients or national supervisors do not share their interpretation of SFDR provisions”. 

“While the fact that there are a variety of ESG strategies represented in Article 8 and 9 funds is not in itself a problem, it does become problematic when market participants are not able to – or do not feel it necessary to – easily distinguish between funds,” the PRI’s head of US policy, Greg Hershman, and policy analyst Karen Kerschke wrote in their SEC submission.  

Under SFDR, Article 8 funds promote environmental or social characteristics, while Article 9 covers funds with sustainable investment as their objective.

A key recommendation from the PRI is that the SEC draw on the lessons learned from SFDR and “work with the EU, the UK’s Financial Conduct Authority and others to build a harmonised global system of investor and product disclosure”. 

Jens Peers, CEO of the US arm of Mirova, the sustainability investment house owned by Natixis, also called on the SEC to align its proposed framework with existing ones in Europe. 

Specifically, he highlighted that the three ESG fund classifications set out by the SEC in the proposal “do not align with Article 6, 8 and 9 funds under SFDR”. 

Diverging classification regimes, Peers warned, “could be misleading and will contribute to increased confusion at the end-investor level on the sustainability nature and ambition of the product that is classified in one category or another”. 

PRI pushes for mandatory ESG disclosures for all funds 

On Wednesday, Responsible Investor reported that Morningstar has urged the SEC to “eliminate” the ESG-Integration category from its proposed ruling, warning that it could “contribute to greenwashing”.   

That recommendation was echoed in several submissions, including those from the PRI and two influential US-based fund trade bodies, the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI).  

US retirement services provider TIAA agreed with the positions of SIFMA and ICI, stating that the SEC “should eliminate the ‘Integration Fund’ category in its entirety, and apply its proposed ESG disclosure requirements solely to ESG-Focused Funds and Impact Funds.”   

By contrast, the PRI – whose signatories include many members of SIFMA and ICI – recommended that the requirements in the integration category should instead become a baseline for all funds and not just applicable to those which identify ESG as a part in their process as set out in the proposal.  

“By requiring all funds to ‘summarise in a few sentences how the fund incorporates ESG factors into its investment selection process, including what (if any) ESG factors the fund considers’, the SEC would eliminate the impression that ESG factors are somehow different to other investment relevant factors and instead signal that considering ESG factors is a fundamental part of financial risk management,” it wrote.  

The PRI also recommended that all funds should disclose if and how they consider the impacts of their investment decisions. “This disclosure will better reflect market realities that all investments, and all funds, have impacts,” it wrote. 

Pushback from fund trade groups and big managers  

Overall, ICI was critical of the proposed rule. “Despite our endorsement of the Commission’s goals, we cannot support many parts of the proposal,” it wrote, describing the proposal as “overly complex and prescriptive”  and adding that it “unnecessarily departs from the SEC’s time-honoured approach to disclosure requirements”. 

Investment behemoth State Street Global Advisors, which manages around $3.5 trillion in assets, also pushed back on “elements” of the proposal, which it finds to be “highly prescriptive and complex, particularly in view of the developing nature of ESG data, methodologies and reporting constructs”. 

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

Quantitative disclosure of proxy voting and engagement by ESG-Focused funds that market their use of proxy voting as “a significant means of implementing its ESG strategy” was opposed by State Street, with the manager describing such an “arbitrary metric” as not offering a benefit to investors. 

According to the most recent Voting Matters report by UK-based campaign group ShareAction, State Street supported 32 percent of environmental and social shareholder proposals in 2021.