Financial regulators in the US are cracking down on investment funds that are marketed as climate-friendly but frequently hold shares in high-carbon fossil fuel companies, and have only marginally lower emissions per dollar of revenue than the economy average.
The proposed rules by the Securities and Exchange Commission will require purveyors of exchange-traded funds and other retail investment products labeled as “ESG” to disclose more information about what kinds of companies are included in those funds and the rationale for their inclusion. Today that information is frequently withheld or buried in technical documents that leave average retail investors susceptible to greenwashing. And ESG funds are allowed to hold up to 20% of their shares in non-ESG stocks, so that even funds labeled “fossil fuel-free” can, and do, hold fossil fuel companies. The new rules won’t necessarily close that loophole, but will at least make it easier to spot.
“Right now anyone can call a fund ‘green,’ and ‘green’ doesn’t need to reflect anything real about the fund,” said Greg Hershman, head of US policy for Principles for Responsible Investment, a United Nations-backed research and advocacy group. “This is about setting some rules of the road where today there are none.”
Those rules are increasingly needed as cash pours into ESG funds, which now hold about $41 trillion globally and are expected to reach $50 trillion by 2025. At least 121 new ESG funds were launched in 2021, compared to 31 in 2019.
The new rules follow another SEC proposal in March that will require public companies to disclose data about their carbon footprint. Fund managers will be able to use those data to comply with the latest SEC rule. And on May 23, the SEC gave a first look at how it will crack down on dubious ESG marketing, slapping a $1.5 million fine on BNY Mellon Investment Adviser for “misstatements and omissions” in how it uses ESG criteria (BNY didn’t dispute the charge).
But the new rules won’t resolve the grudge held against ESG by Tesla CEO Elon Musk. His frustration is focused on an intermediate step, in which ratings firms like S&P use company information to devise an ESG score, which in turn can be cited by a fund manager. Tesla’s lack of climate disclosures relative to other automakers, as well as issues with safety and working conditions at its factories, contributed to it receiving a low ESG score from S&P.
The SEC hasn’t yet laid out criteria for ESG rating methodologies—but Hershman said that’s likely to be its next target.