SEC steps into wild west of ESG funds

Growing space draws scrutiny as regulator asks firms what responsible investing really means

SEC steps into wild west of ESG funds

As investors pour more assets and asset managers launch more funds into the ESG space, securities regulators are putting products and firms that claim to be socially responsible under the microscope.

“The Securities and Exchange Commission has sent examination letters to firms as record amounts of money flow into ESG funds,” reported the Wall Street Journal. Such funds are broadly promoted as investing in companies with an eye toward environment, social, and governance issues, though critics question how closely the products actually keep to their promises.

The SEC’s Los Angeles office is reportedly heading the examination of the ESG fund space, according to an unnamed source familiar with the matter. Specifically, the initiative focuses on advisors’ criteria to determine whether an investment is socially responsible, as well as how they apply those criteria and make investments.

One letter sent by the regulator to an investment manager with ESG offerings, which the Journal said it viewed, asked for a list of its previous stock recommendations to clients, its models for identifying environmentally or socially responsible companies, and its best- and worst-performing ESG investments. The identity and number of firms that received letters could not be determined.

The inquiries are being conducted by SEC examiners, who can seek information from a broad group of firms to identify new industry trends or concerns. Firms that are found to be out of step with rules stand to receive deficiency letters based on examiners’ findings; the letters don’t come with fines, though examiners can refer matters to SEC enforcement attorneys for a formal investigation.

In the letter, the SEC asked whether the advisor adhered to well-known policies for socially responsible investing, such as the United Nations’ Principles for Responsible Investment. Proxy voting was also addressed in the letter, as the regulator asked advisors to provider records and documents to show how they decided to vote on a particular ESG issues.

Another potential point of contention, which has been brought up by senior SEC officials, is that an ESG fund’s excessive focus on morality could lead a money manager to neglect their duty to act in their client’s best interest. Republican SEC Commissioner Hester Peirce has noted that retirees and beneficiaries who are not interested in sustainability could be locked into pension funds that pursue ESG strategies. Questions have also been raised on whether fixating in ESG could lead to reduced potential returns.

Also problematic is the lack of agreed-upon standards in ESG. “While financial reporting benefits from uniform standards developed over centuries, many ESG factors rely on research that is far from settled,” Peirce said last year in a speech to California State University Fullerton’s Center for Corporate Reporting and Governance.

Despite the lack of consistent criteria, flows into ESG-focused funds have skyrocketed from US$2.83 billion in 2015 to US$17.67 billion this year through November, according to Morningstar data.


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