June 2, 2022 - updated on June 9, 2022. On May 25th the SEC continued the swift advance of its rulemaking agenda with the release of two proposals aimed at improving the transparency of ESG labels for funds and ensuring investors receive sufficient information about fund managers’ ESG integration practices. SEC Chairman Gary Gensler has long cited the need for improved labelling – analogizing fund names with “nutrition labels” for ESG products. The SEC looks to categorize certain types of ESG strategies broadly and require funds and advisers to provide more specific disclosures in fund prospectuses, annual reports, and adviser brochures based on the ESG strategies they pursue. Funds focused on the consideration of environmental factors generally would be required to disclose the greenhouse gas emissions associated with their portfolio investments. Funds claiming to achieve a specific ESG impact would be required to describe the specific impact(s) they seek to achieve and summarize their progress on achieving those impacts. Funds that use proxy voting or other engagement with issuers as a significant means of implementing their ESG strategy would be required to disclose information regarding their voting of proxies on particular ESG-related voting matters and information concerning their ESG engagement meetings.
The two proposals – each hundreds of pages long – will take time to digest. However, at least at first blush, the proposals – while not themselves surprising – provide for disclosure requirements that exceed industry expectations. As noted by Sidley Austin in their client alert, these proposals represent “a significant departure from the Commission’s existing disclosure framework for the use of any particular investment strategy or approach because it prescribes specific disclosures relating to ESG.” The lack of definitions of “E”, “S” and “G” means that classification rests in the subjective judgment of the fund or adviser. Furthermore, ESG continues to be a fast-evolving field. Given the prescriptive and detailed nature of the proposed requirements, it could prove challenging for investment companies and advisers to adjust to such evolution. Bloomberg argued that the SEC has ignored 80 years of financial science and its “solutions are straight out of the New Deal, top-down playbook from the 1930s”. It will be interesting to monitor the reactions of financial market participants and other stakeholders in the coming days. As members are aware, ESG integration has been adopted by loan investors as it has by investors broadly. Many loan investors have adopted ESG policies, many are PRI signatories, and in some cases, ESG may be integrated explicitly in a fund or structure. For instance, Fitch recently reported that, according to its 2022 CLO Manager Survey, 89% of US-only managers have ESG policies (slightly lagging the 93% of managers with operations in Europe) and “more CLOs are coming on line with ESG-related exclusionary language compared with last year.” Loan market participants, like all financial market participants, will need to carefully consider current and future practices in light of the changing ESG regulatory environment.
It is also important to remember the context for these proposals. This latest effort follows on from the corporate climate reporting proposal released this spring as well as recent notable ESG-related enforcement actions. As previously reported, the SEC is requesting public input on a proposed rulemaking to enhance issuers’ climate-related disclosures. New rulemakings are not needed to see ESG-related enforcement actions. As you may recall, the SEC announced in March 2021 the formation of a Climate and ESG Task Force in the Division of Enforcement with a mandate to identify material gaps or misstatements in issuers’ ESG disclosures under the current regime. The SEC charged Vale, a publicly listed Brazilian mining company, with a multiple violations of the Exchange Act for the company’s misstatements relating to the 2019 collapse of its mine and Brumadinho dam. This case highlights that statements made in sustainability reports and that otherwise fall under the ESG rubric are fair game for the SEC on whether to bring enforcement actions. (For further coverage, please see Crowell and Moring’s alert.) We also know that the last twelve months has seen an increase in the SEC’s request for information from funds relating to ESG-related disclosures. Last week, the SEC took another step charging BNY Mellon with falsely representing or implying that all investments in certain funds had undergone an ESG quality review from July 2018 to September 2021. As reported by Politico and WSJ, BNY Mellon Investment Advisers will pay $1.5 million to settle the charges. (For further coverage, please see Cleary Gottlieb’s alert.) While the SEC’s intentions to bring ESG-related enforcement actions has been well-telegraphed, it does underscore SEC Commissioner Hester Peirce’s dissenting position that existing SEC regulation is sufficient to address ESG issues.
Comments on the two fund proposals are due 60 days after the publication of the proposals in the Federal Register (which has not yet occurred so the end of July at the earliest). After further review, the LSTA will share further commentary on the implications of the proposals for the loan markets as it considers its own submission in response to the proposals.