With so many potential new rules regarding climate and ESG disclosures, how can you figure out which ones apply to you?
On March 21st and May 25th, 2022, the Securities and Exchange Commission released proposed amendments regarding disclosures about climate risks and ESG investment practices. When considered together, these sets of amendments amount to hundreds of pages of intricate details regarding how companies and funds inform investors and regulators of their practices. How can you know which of these rules affect you and what you’ll need to look out for?
To better understand what these proposed changes mean and how they will affect the industry, JTC hosted a webinar that is now available for free online. Titled, “The SEC and ESG: What Happens Next,” it featured a panel of experts discussing what has been proposed, where we stand now, and what smart companies are doing to prepare. Their insights can help investors, fund managers, and service providers adapt to what’s coming.
The SEC is doubling down on enforcement
The panelists discussed the SEC’s campaign against greenwashing, which has included major investigations of BNY Mellon Investment Adviser, Inc., resulting in a fine of $1.5 million, and DWS Group, the asset management arm of Deutsche Bank, whose CEO resigned after the company’s offices were raided by German authorities.
“I think we’re beyond the point of being able to just pay lip service” with regards to ESG, said Barbara A. Jones, Co-Managing Shareholder, Los Angeles, Greenberg Traurig, LLP. “The regulators have made it clear: they’re going to hold your feet to the fire.” Investors are also increasingly demanding proof that companies are really walking the walk on ESG.
While the two proposed sets of amendments both came this year, they are quite different in who is affected. The May 25th amendments pertain to funds that advertise an impact focus or include terms like “ESG” and “Impact” in their names, so any fund manager promoting a fund’s ESG considerations should take note.
What ESG-focused funds need to watch out for
According to Jones, enforcement is becoming more of a priority for the Securities and Exchange Commission: “the enforcement division is considering that there is a high risk of greenwashing out there in the market,” she said. The SEC is looking not only at public companies’ reporting disclosures, but at private funds, registered investment advisors (RIAs), and those providing advisory services, particularly looking at the materials a company puts out.
“It’s going to hold investment advisors accountable when they do not accurately describe their incorporation of ESG factors into the investment selection process,” said Jones. This can include disclosures to governments, marketing materials, or even the name of the fund, if it’s judged to be misleading.
One example given was Vale S.A., a publicly traded Brazilian mining company, which was charged with making false and misleading claims. The SEC looked not only at sustainability reports and public filings, but materials on the company’s website.
“It’s important to take a look at all of the materials that you’re putting out there to the public for consumption, whether they are in your corporate social responsibility report, a sustainability report that you’ve got on your website, or whether it’s in actual filings that are made with the SEC,” said Jones. Since fines “Could be in the tens or hundreds of millions of dollars, depending upon the situation,” fund managers should pay close attention to what they’re saying about their investment products.
Climate disclosure rules that affect funds of all types
While the aforementioned rules mainly affect funds with an ESG or impact focus, the March 21st proposal will affect a much wider range of funds. According to Jones, the proposal garnered more than 10,000 letters during the public comment period, so there are likely to be changes before anything is implemented, but the main problem many see in the current language is just how little it takes to be affected.
At issue is the definition of “materiality,” meaning whether or not a certain change would affect a fund’s performance. As Jones remarked, it is currently “a very, very low threshold.”
“The threshold on the financial analysis is 1%, meaning even a 1% change in financial results due to a climate-related event,” she said. This means that if a fund can expect a change of as little as 1% in its returns due to the effects of climate change, this must be disclosed to investors and the government. Such a low threshold will ensure a massive reporting burden on a lot of companies.
A sign of what’s to come?
Even if we assume these proposals are likely to change before they’re implemented thanks to the thousands of public comments, it’s clear that some form of increased disclosures is coming. To understand what the future might bring, it’s helpful to look to Europe. As noted by Victoria Gillespie, former Director of ESG Services for JTC Group, the SEC often follows in Europe’s footsteps.
The current state of ESG in Europe, according to Gillespie, is very fragmented. “What we tend to see is the local jurisdictions having their own interpretations, and therefore you’ve got a European framework, but also underpinned by localized rules and requirements as well.”
Jurisdictional changes can be extremely complicated when it comes to ESG because you have to take into account where your investors are, where you’re marketing, and where your activity actually is.
“Different regulators have their own expectations, with ESG being so subjective,” said Gillespie.
US funds that fundraise in Europe need to keep this in mind, as well as anyone working with a European-based entity. “If you delegate your investment management to a European entity, you could by coincidence be captured by SFDR [The Sustainable Finance Disclosure Regulation] as well.”
How to make sense of all this
If you work with funds that have an ESG focus and those that don’t, with US-based investors and European ones, and operate across many jurisdictions, you’ll probably need help sorting through the final version of these disclosure rules. Unfortunately, many fund managers have neither a full-time Chief Sustainability Officer nor a third-party company to help with ESG.
“People don’t know where to start or don’t have the resources to really imbed what they would like to achieve,” said Gillespie, which is why JTC has created its virtual Chief Sustainability Officer platform, which helps funds in areas of Strategy, Training, and Carbon Footprint reduction without the need to hire a full-time CSO. In addition to the vCSO solution, JTC has a global presence in more than two dozen jurisdictions and can help with the complexities of global ESG compliance.
Barbara Jones put it best during the webinar: “This issue isn’t going away.” ESG compliance is the way of the future, and JTC is ready to work with our clients and partners to meet whatever challenges arise.
At the webinar, the panelists also discussed specific regulations and what needs to be disclosed in terms of climate risks, the three types of ESG-related funds defined by the May 25th amendment and what compliance would look like for each, and board diversity and governance rules that could potentially be on the way. They also answered questions from attendees regarding topics like whether being a public or private company will make a difference under the SEC’s proposed rules.