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Bob Smith, Sage Advisory

Sage Advisory and Planet Tracker comment on sustainable regulations both sides of the pond


In Europe, March has seen the introduction of the Sustainable Finance Disclosure Regulations (SFDR), that mandate greater transparency for ESG funds, requiring fund groups to provide information about the ESG risks in their portfolios.  

At the same time, the US’s regulatory body, the SEC, has announced that it is to create an enforcement task force focused on climate and ESG Issues. The task force will be led by Kelly L. Gibson, the Acting Deputy Director of Enforcement, who will oversee a Division-wide effort, with 22 members drawn from the SEC’s headquarters, regional offices, and Enforcement specialised units.       

John Willis, Director of Research at Planet Tracker, says: “The SEC announcement is encouraging and adds to the momentum of sustainability/ESG that the Biden Administration is pushing. 

“It’s hard to believe that only last October the US DoL ruled that ERISA plan fiduciaries cannot invest in ‘non-pecuniary’ vehicles that sacrifice investment returns or take on additional risk, though the final rule focused less on ESG than the proposal on which it was based. The Biden Admin announced it was reversing this rule in late January.” 

Regarding its enforcement initiative, the SEC writes: “Consistent with increasing investor focus and reliance on climate and ESG-related disclosure and investment, the Climate and ESG Task Force will develop initiatives to proactively identify ESG-related misconduct.  The task force will also coordinate the effective use of Division resources, including through the use of sophisticated data analysis to mine and assess information across registrants, to identify potential violations.” 

Initially the focus will be to identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules and the task force will also analyse disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.  

The SEC writes that its work will complement the agency’s other initiatives in this area, including the recent appointment of Satyam Khanna as a Senior Policy Advisor for Climate and ESG. It adds that, as an integral component of the agency’s efforts to address these risks to investors, the task force will work closely with other SEC Divisions and Offices, including the Divisions of Corporation Finance, Investment Management, and Examinations. 

In addition, the Climate and ESG Task Force will evaluate and pursue tips, referrals, and whistleblower complaints on ESG-related issues, and provide expertise and insight to teams working on ESG-related matters across the Division.  ESG related tips, referrals and whistleblower complaints can be submitted here. 

Commenting on the announcement that the task force will review proxy voting policies for investor risks on climate change and ESG matters, Robert Smith, President and CIO of Sage Advisory says that his firm welcomes this action. “It will give investor-led proposals a decent chance for a hearing and vote if it conflicts with management and it will force large shareholders and fund management companies to identify what their actual voting policies are vs. what they claim,” Smith says. “This should also go further to evaluate why large fund companies decide not to vote their proxies but would rather ‘engage’ with the company to effect change. This is too vague and incomplete in terms of fiduciary accountability and consistency from a proxy voting policy application perspective. We have commented on this in our Annual Stewardship Survey’s for the last couple of years.” 

In terms of reviewing funds for false or misleading statements, as well as analysing their proxy voting policies, Sage agrees with this intention as a measure to prevent or correct ‘greenwashed’ marketing techniques and surface rebranding of existing conventional non-ESG or Impact oriented funds as originally conceived. 

Smith says: “This should also extend to the track records that these very same funds are presenting to investors to suggest a long-term history of applying ESG investment principles to a given fund when this is false, and the performance was not derived through the application of ESG investment philosophies or processes prior to the rebranding date.  

“The investigation of proxy voting consistency across funds for identical companies needs to be looked at as well. Too much discretion is given to different PMs or investment teams to vote proxies differently for a given company within the same investment firm. This needs to be fully disclosed by the fund managers in full detail and explained to investors as well as the respective companies that they are voting on,” he says. 

In terms of reviewing whether firms’ practices match sustainability disclosures distributed to investors, particularly for ESG designated or branded mutual funds and ETFs, Sage agrees with the effort to help prevent ‘greenwashing’ or what it calls ‘bait & switch style’ techniques that could result in poor or unintended outcomes for investors.  

“There is little doubt that managers are now quickly reviewing their marketing documents to make sure their disclosures were accurate, and their practices are indeed in accordance with what they are stating in their strategies. We try to evaluate these concerns, in large measure, through the questions we feature in our Annual Stewardship Survey,” Smith says. “The SEC’s efforts in this regard seem very similar to regulatory efforts in the EU where investment firms must prove or corroborate their respective green investment claims with hard evidence or otherwise be fined and publicly admonished on the record. In other words, if you sell the concept of green investing to build assets then you must provide proof of concept in the fund on an ongoing basis.” 
The task force will also review firms’ business continuity plans in the event of climate-related physical disasters and Sage writes that this is an effort to be consistent in the application of ESG risk analysis and policies. “The SEC seems to be suggesting that traditional or standard conventional business continuity or disaster recovery plans will not be adequate to pass muster,” Smith says.  

“One wonders if perhaps they will require everyone to become B Corp certified or produce a Corporate Social Responsibility Report (CSR) before they will be allowed to operate their businesses as investment service firms. This requirement will be hard to pull off given the variety of climate-related physical disasters that might exist in each region or location for a firm. This is particularly true for larger geographically dispersed firms that have operations in varied climate environments.  

“Since flooding is the largest natural disaster that afflicts most of the country, I would guess the first question on the SEC list of questions for this subject ought to be: ‘Do you have flood insurance?’ 

“It will be interesting to see what they might require in terms of climate risk-related mitigation and preparedness plans for each investment management and brokerage firm. Perhaps these firms might require some form of FEMA review or certification…this one is an odd one the more you think about it.” 

Finally, the task force will examine whether investment firms can manage cyber risk as office workers continue to work from home and Smith comments that this might be too much over-kill that has arrived a bit too late.  

“This was last year’s challenge and concern with the arrival of the pandemic. If we have not seen a giant flare-up on this coming from the investment securities or investment management industries, then most firms have probably dealt sufficiently with it and have little to be concerned about if they are still operating well today,” he says.  

“Of course, this is a constantly evolving challenge for all forms of financial intermediaries so a moderate regulatory assessment of communication capabilities, tech staffing and budgetary funding adequacy might be helpful to ensure the integrity of the system.” 

In conclusion, Smith says: “We cautiously approve of the SEC’s new intentions to integrate climate and ESG considerations into the Agency’s broader regulatory framework and will look forward to seeing what they unveil in terms of additional details and requirements. These steps clearly indicate how much attention the SEC will now give to sustainable investments, which were once considered a marginal matter. We also hope that these announcements will have an influence on the direction of investment regulations with other regulatory organizations such as the Department of Labor which continues to move in an opposite direction regarding ESG investment activities.” 

Commenting on the US proposals, against the backdrop of Europe’s approach, Planet Tracker’s Willis says: “Really this is catch-up compared to the EU which is presently the rule-setter on ESG and sustainability issues. March 10th saw the EU Sustainable Financial Disclosures Regulation’ (SFDR) provisions came into force. This requires all financial market participants in the EU to disclose ESG issues, with additional requirements for products that promote ESG characteristics or that have sustainable investment objectives.    

“EU regulators and politicians are already on the case and well ahead of the US. Meanwhile, in Europe, March sees the introduction of the Sustainable Finance Disclosure Regulations (SFDR), that mandate greater transparency for ESG funds. SFDR requires fund groups to provide information about the ESG risks in their portfolios for the first time.     

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