SEC Proposes ESG Disclosure Rules for Investment Advisers and Funds

Practical Law Legal Update w-035-7146 (Approx. 5 pages)

SEC Proposes ESG Disclosure Rules for Investment Advisers and Funds

by Practical Law Corporate & Securities

Published on 26 May 2022 • USA (National/Federal)

The SEC proposed amendments to rules and forms under the Advisers Act and Investment Company Act to require certain investment advisers and funds to disclose information about their ESG investment practices.

Update: On October 7, 2022, the SEC reopened the comment periods for several rulemaking releases due to a technical error that resulted in the SEC not receiving comments submitted through its online form between June 2021 and August 2022. The SEC's below proposed rule was one of the affected releases. The reopened comment period will remain open for 14 days after the reopening release is published in the Federal Register. For more information, see Legal Update, SEC Reopens Comment Periods for Several Proposed Rules.

On May 25, 2022, the SEC proposed amendments to rules and forms under the Advisers Act and Investment Company Act to require certain investment advisers and funds to disclose information about their ESG investment practices.

The SEC's proposed rules define three types of ESG funds based on the extent ESG factors are considered:

ESG Integration Funds. Integration Funds consider ESG factors alongside non-ESG factors when making investment decisions, and ESG factors may not be dispositive.
ESG-Focused Funds. ESG-Focused Funds focus on one or more ESG factors by using them as a significant or main consideration in selecting investments or in engaging with portfolio companies.
ESG Impact Funds. A subset of ESG-Focused Funds, ESG Impact Funds have a stated goal that seeks to achieve a specific ESG impact or impacts that generate specific ESG-related benefits.

The level of detail required by the proposed disclosure rules is then dependent on which ESG fund definition is met. An Integration Fund would provide more limited disclosure, whereas ESG-Focused and Impact Funds would have additional disclosure requirements, including more detailed GHG emissions reporting for funds considering environmental factors. Certain ESG-Focused Funds that use proxy voting or engagement with issuers as a significant means of implementing their ESG strategy would also be required to disclose information about their proxy voting or ESG engagements.

The SEC is proposing generally similar disclosure requirements for investment advisers through a number of proposed changes to the brochure in Part 2A of Form ADV. Among other proposed changes, proposed new sub-Item 8.D would require a description of the ESG factors considered for each significant investment strategy or method of analysis for which the adviser considers any ESG factors. Based on similar categories as the defined fund types, the description in the brochure must include:

For integration strategies, a brief explanation of whether and how the adviser considers ESG factors alongside non-ESG factors.
For ESG-focused strategies, an explanation of whether and how the adviser uses ESG factors as a main consideration in advising clients with respect to investment or engagement strategies.
For ESG impact strategies, an overview of the impact the adviser seeks to achieve and how it is seeking it, including:
- how progress toward the stated impact is measured;
- key performance indicators being analyzed;
- the time horizon used to analyze progress; and
- the relationship between the impact sought and financial returns.

Proposed sub-Item 8.D would also require disclosure of the criteria or methodology used for evaluating, selecting, or excluding investments as part of a significant ESG investment strategy, including a description of how the adviser uses:

Internal or third-party scoring methodologies, and if using a third-party, how it evaluates the quality of the relevant third-party data.
Inclusionary or exclusionary screens, and what exceptions apply.
An index, including the name of the index and a description of how the index utilizes ESG factors in determining its constituents.

For more information on Part 2A of Form ADV, see Practice Note, Investment Adviser Regulation: Overview: Brochure Rule.

The SEC's release also reaffirmed existing obligations of investment advisers as it relates to ESG investment strategies and disclosures. For example:

If an adviser discloses to investors that it considers certain ESG factors as part of an integration strategy, the adviser's compliance policies and procedures should be reasonably designed to ensure the portfolios are managed consistently with how the strategy was described.
Policies and procedures for ESG-related proxy proposal practices should be consistent with disclosures to investors.
The marketing rule prohibits advisers from distributing advertisements with untrue statements of material facts, such as overstating the extent to which the adviser utilizes an ESG investment strategy.

For more on the compliance obligations of investment advisers and the marketing rule, see Practice Notes, Investment Adviser Regulation: Overview: Compliance Program and The Investment Adviser Marketing Rule.

In addition, the SEC is also proposing amendments to ADV Part 1A and Form N-CEN to collect census-type information about investment advisers' and funds' use of ESG factors.

The comment period for the proposed rules will remain open for 60 days after publication in the Federal Register.

For more information on key developments relating to climate and ESG disclosure, see Practice Note, Key Developments in ESG and Climate Disclosure Tracker. For a collection of Practical Law resources across practice areas relating to ESG, see Environmental, Social, and Governance (ESG) Toolkit: US.

For up-to-date information on the status of significant SEC rulemaking, see Practice Note, SEC Rulemaking Tracker.

SEC Proposes ESG Disclosure Rules for Investment Advisers and Funds | Practical Law