Sustainable Snapshot | April 27, 2021

Standards are on tap for ESG investing after a ‘risk alert’ from the SEC

Henry Shilling
Guest Author

Henry Shilling

Editor’s note: ImpactAlpha is partnering with Sustainable Research and Analysis LLC to provide timely market snapshots of trends and developments affecting the sustainable investing market.

Earlier this month, the Securities and Exchange Commission’s Division of Examinations issued an expression of concern based on recent examinations. Published in the form of a non-binding Advisory Risk Alert, the examinations division observed a disconnect between environmental, social and governance, or ESG, product offerings by investment advisers, registered investment companies, and private funds, on the one hand, and the implementation of ESG-related approaches on the other. 

The Division of Examinations should be applauded for highlighting these issues. The Risk Alert represents a wake-up call for the investment industry to take up the challenge of developing widely accepted standardized and more precise sustainable investing definitions, a framework for investment products classifications as well as a set of disclosure practices.

The findings do not come as a surprise. Contributing to the confusion: Unprecedented growth in sustainable investment product offerings in the US, involving mutual funds and exchange traded funds, or ETFs. The increase was largely attributable to fund re-brandings, followed by market appreciation and net cash inflows.

This has led to misunderstandings on the part of stakeholders as to the differences between values-based investing, reflecting social or ethical investing considerations, and “ESG integration,” in which relevant and material risks and opportunities are taken into account in the evaluation of securities. 

To ensure continued growth and development in the sustainable investing sector and to allow it to reach its full potential, Michael Cosack and I advocated for the adoption of standard-setting initiatives, including the adoption of standardized definitions, creation of accepted mutual fund/ETF product classification framework and the adoption of an effective disclosure framework. The outline of our May 2020 paper is summarized in the table below.

The Risk Alert sets out areas of focus for the Division of Examinations during upcoming examinations of firms that claim to engage in ESG investing, including portfolio management, performance advertising and marketing and compliance programs. 

It is now up to the investment management industry to respond and help shape any SEC initiative.