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The U.S. Securities and Exchange Commission is influential in securities industry enforcement, and its regulations are expected to influence other jurisdictions, including Canada.Andrew Kelly/Reuters

The U.S. Securities and Exchange Commission has drafted tougher rules for mutual funds and advisers aimed at preventing them from making misleading environmental, social and governance claims, as billions of dollars flow into such investments.

Commissioners voted 3-1 on Wednesday to send the proposed rules to improve transparency out for public comment. The rules would demand stricter reporting of criteria for the investment strategies being employed by fund managers to stop the practice of greenwashing: making false or exaggerated environmental declarations.

“When an investor reads current disclosures, it can be very difficult to understand what funds mean when they say they’re an E, an S or G, or ESG fund. There also is a risk that funds and investment advisers mislead the investors by overstating their focus on any one of these factors, or on ESG,” SEC chairman Gary Gensler said during a public meeting of the commissioners.

“People are making investment decisions based on a variety of disclosures, and it’s important these disclosures be presented in a meaningful way for investors. What information stands behind a fund’s claims? Which data or criteria are funds using to ensure they are meeting investors’ targets?” Mr. Gensler said.

Fund names would also have to accurately reflect the main focus of the investment strategies, to prevent misleading and deceptive claims.

The SEC is influential in securities industry enforcement, and its regulations are expected to influence other jurisdictions, including Canada. The Canadian Securities Administrators, the umbrella group for provincial securities commissions, recently published its own guidance aimed at improving disclosure of ESG-themed funds. They too are meant to prevent greenwashing, and the organization has said it would monitor such funds for disclosure so investors aren’t misled.

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Europe leads the world in demanding better data from providers of sustainable investments, and the SEC looks to be moving closer to those standards. Canadian regulation will follow as well, said Baltej Sidhu, ESG analyst at National Bank of Canada. “The bigger nations are going to be more susceptible to change faster,” he said.

The SEC is cracking down as investor appetite surges for investments that meet financial goals as well as environmental and social ones, such as accelerating the transition to a low-carbon economy or improving access to health care. At the end of 2021, assets in ESG-themed mutual and exchange-traded funds totalled US$2.74-trillion worldwide, up 53 per cent from the year before, according to Morningstar. The United States represents 13 per cent of the total, and Canada 1 per cent.

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This week, the SEC fined BNY Mellon US$1.5-million for misstatements and omissions about ESG factors used in making investment decisions for some of its mutual funds. The regulator said that from 2018 to 2021, BNY Mellon implied the funds had been subjected to an ESG quality review when that was not always the case. The penalty only heightened concern about greenwashing in the investment industry, which has helped fuel a growing backlash against sustainable investing .

The SEC’s proposed rule changes mandate more stringent reporting of criteria in annual reports, prospectuses and adviser brochures for different types of funds that have ESG metrics as part of their investment strategies. In the case of an integration fund, ESG is among other factors used in investment decisions. Managers would have to describe how the ESG factors are incorporated.

ESG-focused funds would have to provide more detailed disclosure, including an ESG strategy overview table. Those funds that consider environmental factors would be required to disclose additional information about greenhouse gas emissions associated with their investments, including the carbon footprint and weighted average carbon intensity of the portfolio. This is aimed at meeting investor demand for comparable data on carbon emissions, the SEC said.

In the case of impact funds, which aim to achieve particular environmental or social improvements as a main focus of their investment strategies, they would have to disclose how they measure progress toward those objectives.

Advisers who consider ESG factors as part of their investment strategies would have to disclose similar information about their methods of analysis.

The one SEC commissioner who opposed the toughened policy, Hester Peirce, who was appointed by then U.S. president Donald Trump, warned the new measures were too costly and prescriptive on the industry. “It avoids explicitly defining E, S and G, yet it implicitly uses disclosure requirements to induce substantive changes to funds’ and advisers’ ESG practices,” Ms. Peirce said. “Investors will pick up the tab for our latest ESG exploits without seeing much benefit.”

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