August 17, 2022 - In May the SEC proposed rules requiring specific ESG disclosures to be made by registered funds and BDCs as well as registered investment advisers (RIAs). The proposal contemplates a tiered approach to disclosure with enhanced disclosures being required of funds and RIAs that include ESG factors to a greater degree. While the SEC’s stated objective to address concerns that the current lack of consistent, comparable, and reliable information can create a risk of a mismatch between actual ESG considerations and investor expectations and that funds and advisory services may be marketed in a manner that exaggerates their ESG focus resulting in the practice known as “greenwashing” enjoys broad support, the manner in which the SEC’s proposal purports to achieve that objective is expected to draw heavy comments from the investment management community. It is on these lines that the LSTA responded to the proposal.
LSTA unequivocally supports the tenet that funds and RIAs are legally and ethically required to engage in responsible advertising when it comes to ESG. Funds and RIAs should not overstate or otherwise mislead investors on the impact of ESG considerations in their investment selection. However, apart from ESG labelled funds and strategies, there is a broad and evolving spectrum of ESG integration in investment selection. It is critical that ESG considerations are not unduly given greater prominence than other aspects of the investment management process. To strike this balance LSTA urged the Commission to ensure that the final rules relating to the proposal:
- Are predicated on the fund or RIA holding itself out as being an ESG fund or pursing an ESG strategy;
- Retain the traditional standard of materiality throughout its provisions; and
- Define what “ESG” is not.
Specifically, the “Integration” and “ESG-Focused” categories are too broad as currently drafted – it is crucial that the categories are appropriately defined so that mainstream asset management techniques, such as the use of negative screens, compliance with laws and fundamental credit analysis does not in and of themselves trigger one of the ESG categories. Also, LSTA does not view mandatory greenhouse gas emissions disclosures as appropriate for registered funds or BDCs that are not pursuing an explicit carbon- or climate-based strategy. Furthermore, the lack of a definition of “ESG” is appropriate, but some clear direction on what is not “ESG” is needed. To prevent second guessing, the fund or adviser’s good faith determination on ESG should be respected.
Most critically, with respect to ESG information on private companies, LSTA strongly urges the SEC to leave market-driven efforts to increase ESG disclosure on a voluntary basis undisturbed. Credit investors are seeing the need for improvement in the quality of ESG information, particularly the need for quantitative and comparable information, and are actively working with their end investors/asset owners and companies to develop a market-based solution to address the stated goals of the SEC. These efforts take into account the resource limitations on borrowers and a realistic timeline for their development of ESG capabilities while still driving forward meaningful improvement. Given the resource constraints and education needed for these companies, the ability to have a sequenced, iterative approach is critical. This approach is executed more successfully in a voluntary disclosure context. These efforts are being led by LSTA’s recent partnership with the UN PRI and the Alternative Credit Council to harmonize current disparate and competing ESG information requests. LSTA questions whether the costs, undue burdens and market frictions the SEC’s proposal would bring to debt investments in private companies in light of these active efforts to be unreasonable. The SEC’s lack of inclusion of these costs in their estimate underpinning their cost benefit analysis together with the existence of a reasonable alternative, i.e., allowing market-driven voluntary disclosure evolve, calls into question whether the SEC has satisfied their burden under the Administrative Procedure Act.