Why Investors Should Care About What the SEC Is Doing on ESG
Contributors: Jasmin Sethi & Anchal Goyal
So, what is this uproar over ESG? Do investors care? Do we need more disclosure?
The SEC thinks so and so does SCA client, Morningstar. SCA represented Morningstar’s views to the SEC on its recent proposals regarding ESG fund disclosures and corporate climate disclosures.
We advocated for more information to empower investors. In short, we said that funds should say what they do and do what they say.
The SEC tried to improve how funds represent themselves with respect to their ESG activities and managed to make things more confusing than they already are. For instance, the SEC proposed creating a category called “ESG Integration” and we want to change that. “Integration” makes it seem like the companies are doing a lot more than they actually are. Greenwashing may worsen as funds might be required to disclose all ESG factors they considered but never integrated. We recommended that the SEC rename the category to “ESG Consideration” to be truer to the spirit of the fund.
We define ESG Consideration funds as funds that consider ESG alongside many other factors. ESG Consideration funds incorporate ESG without orienting their entire investment process and outcomes around it. By contrast, we define “ESG Integration” funds as those that broadly integrate ESG criteria throughout their investment processes. They exhibit higher levels of commitment to sustainable investing than ESG consideration funds.
We also encouraged the SEC to see sustainable funds as on a continuum rather than in bright-line categories. Rather than adopting the “ESG Focused Fund” category with Impact Funds as a subset, as the SEC proposed, we support the use of a continuum framework with impact as one end of the continuum with requirements to disclose metrics demonstrating their impact.
In addition to funds, the SEC is requiring corporate issuers to make more disclosures about their climate impact. On this topic, we said corporates should disclose clearly their carbon footprint and how they are doing against their climate impact targets.
GHG emissions should be disclosed in all forms – the aggregate, per scope, and on a disaggregated basis for each type of GHG included in the SEC’s proposed rule. We agree with the SEC that Scope 1 and Scope 2 emissions should be disclosed, and any firms with Scope 3 targets should disclose those as well. This last one is controversial as it involves emissions up and down the supply chain. We know it will take time. but without the requirement for disclosure, the means to measure these emissions will not develop. Once these disclosures are required, the market and industry services will evolve to fill the needs that firms have in order to satisfy their regulatory obligations.
The SEC has made a great start when it comes to ESG disclosures. However, the rules still need to be finalized and litigation is expected. The politicization of information about ESG is harming the ability of investors and companies in ascertaining their true impact on the environment, and we hope that better information ultimately wins out over any other outcome.
Jasmin Sethi is the CEO of SCA. She works with clients to advocate for regulations impacting ESG disclosures relevant to investors. She educates on how individuals and institutions impact ESG through investment decisions. She also works with firms to develop ESG policies to further their own mission and that of their clients.
Anchal Goyal is a third-year law student at Cardozo Law School and a Research Associate at SCA.