As discussed in our prior blog post, the DOL has recently been more receptive to permitting retirement plan fiduciaries to consider Environmental, Social, and Governance issues (“ESG”) when considering investment funds. The DOL’s tentative acceptance of ESG factors in the last few years mirrors an increased participant demand for products and strategies that take into account ESG factors into account.
To meet this demand, numerous products and services bearing the “ESG” title have arrived on the market. However, with no regulation over what, exactly, ESG means, these funds each offer their own interpretation. Different funds focus on different ESG factors, ascribe varying weight to those factors, and set different goals for the ESG funds. With the numerous choices and the absence of a regulatory framework, fiduciaries do not have an accurate and reliable method to understand how ESG factors are used by funds or how to differentiate between funds. The lack of specific requirements for ESG has created an environment where ESG may be use more as a marketing strategy than actual practice, a practice that is referred to as “greenwashing.”
To address these practices, last week the SEC proposed that ESG funds provide specific and meaningful disclosures regarding ESG strategies in fund registration statements, discussion of fund performance in annual reports, and in adviser brochures. The level of detail required for any disclosure will depend on how much ESG factors are part of the fund decision making process.
For “ESG-focused” funds (i.e., funds that employ ESG factors as a component in their investment process), the SEC proposed certain minimum disclosure requirements. In general, these focused funds would be required to disclose their progress in achieving their ESG goals in both qualitative and quantitative terms. The funds would also have to disclose how proxies were voted with regard to ESG matters and disclose standardized metrics in annual reports. The metrics are expected to provide investors, such as plan fiduciaries, the ability to compare funds and help meet their own ESG goals.
For “ESG integration” funds (i.e., funds that consider ESG factors among other factors), the proposed rule requires more limited disclosures. For these funds, the disclosure is generally limited to how the fund incorporates ESG factors into its investment selection process. This summary is intended to be more general in nature so that the ESG factors are not over-emphasized in any disclosure when such funds generally consider numerous other non-ESG factors.
While additional regulation is not always welcome it is hoped this proposed rule will provide clarity to fiduciaries who are considering ESG factors for their plans. For those fiduciaries, the proposed rule, if finalized, will provide some much needed information around how the ESG factors are used and how integral those factors are to the funds themselves.
If you have any questions about ESG investing for retirement plans, or fiduciary duties or investing in general, please contact of the Graydon’s EB team.
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