Your ESG investments are about to face heavy scrutiny

What’s happening? The SEC has launched a probe into ESG funds run by Goldman Sachs’ asset management division, according to a report by the Wall Street Journal. It cited anonymous insiders, who said it was part of a civil investigation and could result in no formal action. Goldman has at least four funds labelled as “clean energy” or ESG following the rebranding of its Blue Chip fund to the US Equity ESG fund in June 2020. The SEC launched an ESG taskforce in 2021 and has proposed new rules to broaden the naming rules for ESG funds and to require greater disclosure on issues such as greenhouse gas emissions and proxy voting records. (Investment Week)

Why does this matter? A recent analysis of 300 funds – worth around $350bn in assets under management – which use green or environmental language found that only 12% of them are on track to meet the Paris Agreement’s climate goals. It’s clear these funds must do more to address environmental issues, and it’s possible many of them are engaging in greenwashing or mislabelling.

Regulators target ESG funds – The investigation of Goldman Sachs is the latest in a series of SEC enforcement actions regarding ESG compliance. The Commission fined BNY Mellon $1.5m in May for misleading investors about the incorporation of ESG factors into its selection process for funds. In April, it also charged Brazilian mining firm Vale for misstating to investors regarding the safety of its dams.

One of the most notable cases occurred last summer when the SEC, along with BaFin, opened an investigation into DWS for overstating its use of sustainable investing criteria in managing assets. As part of the investigation, German police recently raided the offices of DWS. The day after, the firm’s CEO resigned. DWS altered its ESG criteria following the revelations last year, and after this the number of ESG assets it reported in March was 75% below the €459bn it reported in 2021.

New naming rules for funds – Two days after the SEC fined BNY Mellon it proposed rules clarifying how ESG funds should market their names and investment practices. Its Names Rule would extend to “any fund name with terms suggesting that the fund focuses in investments that have (or whose issuers have) particular characteristics”. This means funds with “ESG” in their name would have to define the term and make sure 80% of assets in the fund meet this definition.

The proposed Names Rule would apply to all funds and will cover terms such as “growth” and “value”. The amendments are expected to particularly impact thematic ETFs.

The SEC also said it will be examining proxy voting behaviour. It expects firms that use proxy voting as a large part of their ESG strategy to disclose information relating to the voting of proxies on ESG-related matters.

Regulators draw the line – The increased regulatory scrutiny faced by ESG funds shows that asset managers can no longer hide behind subjectivity when it comes to ESG. Since many of these funds are underpinned by ESG ratings, it’s crucial that ESG ratings providers offer accurate ratings. This part of the industry has, however, faced its own criticisms.

Recent research has found that ESG ratings from six different providers disagree substantially on how indicators are measured. Some market participants believe that ESG ratings should have a separate element for individual E, S and G scores and many are also calling for regulators to take a greater oversight of ESG ratings providers.

The prospect of ESG ratings regulation – In April, the EU launched a consultation on its proposed requirements for ESG ratings providers. The UK Sustainable Investment and Finance Association (UKSIF) has also called on the UK’s FCA to regulate the sector.

In response to the EU’s consultation, Eurosif said that incoming EU disclosure regimes should improve the quality of company-level ESG data and hence products that use these datasets. Therefore, any decision to regulate ESG data products should be made after the adoption of these reporting frameworks, Eurosif said.

Other regulators from France (AMF) and Holland (AFM) support the need for regulation – while all three entities emphasised that improving transparency of methodologies should be the main objective for regulating the sector, as supposed to opting for the complete standardisation of methodologies.

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