In the December 16, 2019 edition of The Wall Street Journal, Juliet Chung and Dave Michaels’ article, “ESG Funds Draw SEC Scrutiny,” reports that the SEC has begun sending examination letters to firms as a result of “record money flow into ESG funds.” If, in fact, the SEC has started taking a closer look at ESG, it is a positive development for the industry.
Environmental, Social and Governance (“ESG”) issues have been making headlines throughout 2019: regulations related to the incorporation of ESG have been announced in other jurisdictions (e.g., the EU’s Action Plan on Sustainable Finance), and standard setters, globally recognized pension funds and industry practitioners (among others) have been actively managing ESG risks (e.g., initial divestment activities related to coal). Further, certain issuers that were previously identified as “ESG friendly”, listed on ESG indices and managers purporting to manage ESG funds that ultimately contained investments in one or more “sin industries” have stood by while they’ve become poster children for sub-par ESG engagement.
However, investment advisers across the U.S. have been subject to reporting standards abroad chiefly due to investor requests for information. These same advisers have not been afforded the standard or protection of U.S. regulation to drive the reporting format or level of disclosure that is ultimately provided.
While the SEC has been largely silent on the topic of ESG, Monday’s article signals that it is beginning to gather information specific to those investment advisers who actively engage in ESG strategies (i.e., advisers that offer impact funds, ESG funds, etc.). Investment advisers interested in ESG want the regulator’s opinion, and have been asking for the SEC to explain how the strategies fit within the regulatory framework in the U.S. Until last week, we’ve been met with comments that current regulation is sufficient to instruct fiduciaries on how to implement ESG.
For decades the SEC has conducted “sweep exams” to understand trends and topics rippling through the financial services industries. You will immediately remember the SEC’s cybersecurity sweep exam. This exercise allows the SEC to learn how investment advisers are managing a trend or risk, including the policies, procedures and processes related to such a trend that advisers have adopted.
The benefit of a well-educated regulator cannot be underestimated. Regulatory intervention can, at times, limit manager flexibility and lead to benchmarking and/or disclosure standards that are inconsistent with the theme under evaluation; however, we are optimistic this sweep exam may result in guidance that will limit the guesswork advisers are currently expected to manage.
If you have received an ESG exam letter from the SEC, or have questions related to your ESG program, please reach out to us: 646-647-1407 | [email protected]
¹This statement is considerate of advisers that are subject to the Investment Advisers Act of 1940, as amended and specifically exempt from the Investment Company Act of 1940, as amended. SEC guidance and communication related to public companies is outside the scope of this comment.