Unpacking the SEC risk alert on ESG investing
On April 9th, the SEC published a risk alert with key insights from their review of ESG investing, which found that investment advisers and funds are making "potentially misleading” statements about ESG investing processes and adherence to global ESG frameworks. The SEC observed that some firms are making unsubstantiated claims about the formal processes in place for ESG investing, for instance having ESG policies and procedures that are not implemented. At a time of growing demand for ESG investing and record capital inflows to ESG funds, the SEC’s risk alert provides a dose of reality about this fast-evolving industry. To industry insiders, it confirmed what many already knew: there are more firms ‘committed’ to ESG integration than really executing on ESG.
What problems were identified by the SEC?
The SEC investigated firms claiming to engage in ESG investing by examining their portfolio management, performance advertising and marketing, and compliance programs, among other aspects. Some of the key problems that staff observed were:
Portfolio management practices differing from client disclosures and other client/investor-facing documents
A lack of adherence to global ESG frameworks which firms claimed they were adhering to
Fund holdings predominated by issuers with low ESG scores, which appeared to be inconsistent with stated ESG approaches
Inadequate controls to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions
Inadequate controls for the implementation and monitoring of clients’ negative screens
Failing to implement clients’ ESG preferences
Inconsistencies between actual firm practices and ESG-related disclosures and marketing materials
A lack of documentation of ESG investing decisions and issuer engagement efforts
Compliance programs that did not adequately address relevant ESG issues
Inadequate policies and procedures addressing ESG investing analyses, decision-making processes, compliance review, and oversight
Difficulties substantiating adherence to stated investment processes
It’s worth noting that SEC staff also observed firms with good practices. They found some firms that accurately conveyed their ESG investing approaches, firms with detailed investment policies and procedures for ESG investing, and compliance teams that were knowledgable on ESG practices.
What are the SEC’s recommendations?
The SEC concludes the risk alert by encouraging market participants to consider:
Accuracy: Review whether claims about ESG investing are accurate and consistent with internal practices
Consistency: Ensure ESG investing is implemented consistently throughout the firm, with oversight from compliance personnel
Evidence: Consider taking steps to document and maintain records relating to important stages in the ESG investing process
What are the implications of the risk alert?
The SEC’s investigation is a sign of the growing scrutiny that firms claiming ESG integration can expect to receive. The scrutiny will only increase as regulators become more active on ESG and sustainable finance, and as clients deepen their understanding of ESG integration. Already, clients are beginning to place greater demands on the asset managers they select, via detailed ESG questionnaires and due diligence. In the past, firms may have been able to stand out by simply having an ESG policy and being a signatory to the Principles for Responsible Investment (PRI), but not any more, as today most asset managers meet this criteria. Firms will have to do more to be able to compete on ESG (and thereby win or retain investment mandates). Going forward, the emphasis will be on the quality, rigour, and depth of ESG integration approaches. ESG integration will need to systematic, and protocols will need to be in place to ensure compliance. To get there, firms will need to invest in new infrastructure and tools to fully embed ESG in the end-to-end investment process. At SustiPortal, we believe that technology will play a critical role in enabling asset managers to implement ESG integration effectively and achieve the future of sustainable finance. If you’d like to learn more, get in touch.