What the SEC’s Increased ESG Focus Means For You
Environmental, Social, and Governance (ESG) considerations aren’t just a growing priority for investors. They are becoming an area of increased focus for regulators, too.
In fact, 2022 was a significant year for U.S. Securities and Exchange Commission (SEC) actions and proposals surrounding ESG, starting in March with proposed amendments to existing rules requiring additional climate related disclosures for publicly traded companies. That same month, the SEC released its 2022 exam priorities, in which ESG was listed as its second highest priority. In 2022, SEC enforcement actions have also demonstrated the agency’s desire to hold firms accountable for ESG-related statements that do not accurately reflect the investment process.
In light of this newfound attention, managers need to know why ESG has become one of the SEC’s top priorities, what the SEC is focusing on, and important takeaways when it comes to recent trends in SEC examinations.
To address those questions, ACA recently spoke with Adam Aderton, Partner at Willkie Farr & Gallagher and Former Co-Chief of the SEC’s Division of Enforcement Asset Management Unit. Leading the discussion were Dan Mistler, ACA’s Head of ESG Advisory Services, and Alyssa Briggs, Managing Director of Client Development for ACA’s ESG Advisory Services.
Here are some of the key takeaways:
What’s driving increased SEC attention?
While ESG has been part of a hot political debate lately, partisanship is not the reason why the SEC has been paying more attention to this topic. "Part of the attention is tied to the growing popularity of this strategy," Aderton said. In 1995, total assets utilizing ESG strategies stood at around $639 billion. That figure grew to $17.1 trillion this year. Another reason is “the recognition that climate topics may present material risks that in some cases should be priced into securities and the SEC is always interested in making sure investors have any information that could be considered material is adequately disclosed to investors,” Briggs said.
What has the SEC proposed?
Climate-related disclosures, proposed in March 2022 and expect to be finalized in April 2023:
- Public companies will have to include certain climate-related disclosures in their registration statements and periodic reports.
- The proposed disclosure would include the company’s governance of climate risks and relevant risk management processes and how those risks have had or are likely to have a material impact on its business, financial statements, strategy, business model and outlook.
- Companies would have to report the impact of climate-related events, such as severe weather events, on their consolidated financial statements.
- Public companies would also be required to disclose information about their direct greenhouse gas (GHG) emissions (Scope 1); their indirect emissions from purchased electricity or other forms of energy (Scope 2); and if a registrant has material indirect emissions within their supply chain, those GHG emissions (Scope 3) must also be reported.
Enhanced disclosures by investment advisers and investment companies on ESG practices, proposed in May 2022 and expected to be finalized in October 2023:
- The proposed amendments would require funds and advisers to provide more specific disclosures in fund prospectuses, annual reports, and adviser brochures concerning their ESG strategies.
- ESG-focused funds would be required to disclose the greenhouse gas emissions associated with their portfolio investments.
- Funds that claim to achieve an ESG impact would be required to disclose the specific impact they intend to achieve and report their progress on their impact.
- Funds that utilize proxy voting or other engagement to implement their ESG strategies would be required to disclose information regarding their proxy voting on ESG matters and information regarding their ESG engagement.
Rules changes to prevent misleading or deceptive names, proposed in May 2022 and expected to be finalized in October 2023:
- The “Names Rule” of the Investment Company Act requires registered investment companies whose fund names suggest a focus in a particular type of investment to invest at least 80 percent of their assets in those investments.
- The proposed amendments would require more funds to adopt the 80-percent investment policy, including any fund with a name that includes terms that would suggest the fund focuses in particular characteristics, including ESG terms.
Areas of concern for the SEC
“Greenwashing is something that has come up in multiple SEC commissioner statements, and it remains a legitimate concern,” Aderton said. From the SEC’s perspective “to the extent there is a mismatch between what investors expect based on your disclosures for what the investment strategy or investment process is going to be and what the actual process is, that remains top of mind for the SEC,” he added. “Exam activity has remained very high with respect to these issues. And in my experience at the SEC, where exams go enforcement often follows.”
Indeed, the SEC recently charged a large, prominent asset manager for policies and procedures failures involving two mutual funds and one separately managed account strategy marketed as ESG investments. The asset manager agreed to pay a $4 million penalty to settle the charges in November without admitting to or denying the SEC’s findings. This appears to be part of a larger theme, as the SEC in May charged another large investment advisor for implying that all investments in certain funds had undergone ESG review “even though that was not always the case.” And a few months prior to that, the SEC charged a robo-advisor for misleading statements implying that its advisory services were compliant with Islamic Shari’ah law, though written procedures were not in place to ensure compliance with the claims.
What can be gleaned from recent developments in SEC exams
"ACA has noticed a slight shift in how SEC exams have been going in the past 18 months," said Mistler. “One of the things we're seeing is lots of focus within engagement in general and proxy voting and voting procedures,” he noted. As a result, “a lot of our clients are proactively looking back into their voting history to understand how things have aligned with what they have promised in their policies. Another trend we're seeing in ESG-focused exams is data and document requests have become more technical", Mistler added. For example, if Greenhouse Gas (GhG) Emissions are a factor in the investment decision making process, managers are expected to provide detailed written documentation of the analysis, including calculation methodology. This might suggest that the SEC is “upskilling” on certain ESG technical areas, such as GHG.
Other clues about SEC priorities
Another area of focus is internal controls and the compliance oversight around ESG reporting submissions, Mistler said. He noted that the UN Principles for Responsible Investment (UN PRI) is a broadly used ESG reporting framework, and many managers use their signatory status with the PRI to support their marketing/fundraising initiatives. As a result, the SEC is paying more attention to it. “We’re seeing that ESG exams of late specifically request data and documentation around the support for PRI responses, and policies and procedures relating to the compliance oversight of the PRI [and other framework] submission process.”
Key considerations for firms going forward
Across 2022, the SEC demonstrated its commitment to investigating ESG-related matters and holding firms accountable for their ESG claims. While the SEC’s proposed rules will increase the level of visibility around ESG practices for agency officials and the public, it is important for firms to recognize that the SEC’s current rules under the Investment Adviser and Investment Company Act of 1940 are sufficient to bring any ESG-related enforcement action and the SEC has demonstrated that it is not waiting for rules to be finalized to identify and penalize wrongdoing. Because of this, firms should scrutinize their internally and externally stated ESG claims to ensure documentation exists to make them fully supportable. It is also essential to train employees across different functions regarding ESG policies and procedures and ensure investment professionals in particular (including junior members of the investment team) are aware of ESG processes and documentation expectations. ACA has observed that SEC examiners have been testing the authenticity of ESG integration by interviewing the newest (and sometimes most junior) members of investment teams.
Additionally, firms should begin the process of preparing for the implementation of the SEC’s ESG-related rules, which is expected to happen in April and October of 2023. “We’re seeing a lot of our clients start to prepare,” understanding that there’s still a lot of uncertainty but with the assumption that many elements of the SEC’s proposals could come to fruition, said Mistler. Getting ahead of these rules will ensure that firms are not scrambling to adjust their processes and procedures, and much of what is outlined in the SEC’s proposals reflect best practices for firms wishing to provide investors with transparent and useful data around ESG matters.
Watch the webcast on-demand
This webcast addressed the latest updates to the SEC's expectations for ESG and shared related insights from our experience, including:
- Observations from ESG examinations and a discussion of SEC expectation
- A discussion of enforcement actions from the SEC’s Climate and ESG Task Force and our expectations for the SEC’s enforcement posture moving forward
- A discussion of proposed ESG rules and their implications for financial firms
- How to prepare for the year ahead
How we help
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