On May 25, 2022, the United States Securities and Exchange Commission (the “SECOND”) proposed a set of new rules to address and improve investor disclosure practices, and related environmental, social and governance policies and procedures (“ESG”) investment considerations and objectives (the “Proposed ESG Disclosure Rules”) by investment advisers of registered investment firms and private funds and other clients. The proposed ESG disclosure rules aim to provide investors with clear and comparable information on how advisors take ESG factors into account. On the same day, the SEC proposed amendments to Rule 35d-1 under the Investment Company Act of 1940 (the “Names Rule”) (the “Proposed Amendments to the Naming Rule”) which, among other things, would significantly broaden the scope of terms used in the names of registered funds that would subject the fund to the requirements of the Names Rule, including terms indicating that the fund’s investment decisions incorporate one or more ESG factors . We’ve briefly summarized both sets of proposed rules below, and we’ll have more details to come.
Categories of ESG strategies and information required
Under the proposed ESG disclosure rules, registered investment companies and registered investment advisers that use ESG strategies in their investment processes would be required to provide ESG information either in the fund prospectus for an investment company. investment registered, or in the brochure (Form ADV part 2A) for a registered investment adviser. The proposed disclosure requirements would vary according to the following three categories of ESG investment strategies:
- Integration strategies. Funds and accounts where ESG factors may be considered in the investment selection process but are generally not decisive over other factors in investment decision-making. The adviser of such a fund or account should disclose how ESG factors influence its investment selection process, including the specific ESG factors considered in investment decision-making and how ESG factors weigh on the factors not ESG.
- ESG-focused strategies. Funds and accounts for which ESG factors are an important or primary consideration in their investment strategy. An adviser to such a fund or account should disclose: (1) whether and how the ESG strategies of the fund or account track an index; (2) whether the fund or account has filters to include or exclude portfolio investment features; (3) the ESG impact(s) the fund or account seeks to achieve (including specific metrics to assess progress); (4) how ESG strategies form part of investment decision-making for the fund or account; and (5) whether and how the advisor uses proxy voting and/or engagement with portfolio companies to advance the ESG strategies of the fund or account.
- Impact Strategies. Funds or accounts that primarily seek to achieve one or more specific ESG impacts. An adviser to such a fund or account would be required to provide all of the same disclosures as for an ESG-focused strategy, but would also need to disclose: (1) how the ESG progress of the fund or account is measured, including performance indicators that the advisor analyzes; (2) the time horizon of the ESG strategy of the fund or account; and (3) the relationship between the impact(s) the fund or account seeks to achieve and financial returns.
The proposed ESG disclosure rules would also require registered investment advisers of funds or accounts with ESG strategies that consider environmental factors to disclose detailed information about the greenhouse gas impacts associated with their portfolio investments, including carbon footprint and weighted average carbon intensity of portfolio investments. .
In addition, the proposed ESG disclosure rules would also require investment advisers registered with funds and accounts to disclose the ESG factors they consider in proxy voting and any material relationships or arrangements between them or its investment staff. management with any related person who is an ESG. consultant or other ESG service provider.
Finally, the proposed ESG disclosure rules would also require census-type regulatory information on ESG matters on Form N-CEN (for registered investment firms) and Form ADV Part 1A (for registered investment advisers and exempt reporting advisors).
Proposed Amendments to the Naming Rule
The SEC adopted the name rule in 2001 to address certain fund names that could mislead an investor about a fund’s investments and risks. The names rule currently requires registered funds and business development companies (but not private funds) whose names suggest a concentration in a particular type of investment, industry, country or geographic region to adopt a investment policy of at least 80% of the value of their net assets in holdings aligned with the name of the fund. Among other changes, the proposed name rule amendments:
- Extend the name rule’s 80% investment policy requirement beyond its current scope to apply to any fund name whose terms suggest the fund is focused on investments that have, or investments whose issuers have particular characteristics, which would include funds with names indicating that the fund’s investment decisions incorporate one or more ESG factors. This broader approach would capture terms such as “growth” and “value” which have historically been considered by the SEC to be investment strategy terminology (as opposed to types of investments) that fall outside the scope of the naming rule.
- Prohibit funds from using ESG or similar terminology in their names where the identified ESG factors do not play a central role in the fund’s strategy. This would mean that funds that consider ESG factors alongside, but not more centrally than other non-ESG factors (known as “integration funds”) would be prohibited from using ESG or similar terminology in their names. .
- Specify the specific circumstances in which a fund may deviate from its 80% investment policy, including specific timeframes for returning to compliance with the 80% investment policy (as soon as reasonably possible, but in any event of cause within 30 consecutive days, subject to certain specified exceptions).
- Requiring that the notional value of derivatives, rather than market value, be used to determine a fund’s compliance with the 80% investment policy, as well as determining what types of derivatives can be included in the 80% basket of a fund.
- Require all unlisted registered closed-end investment companies (such as interval funds) and business development companies that have an 80% investment policy to make that policy “fundamental” so that it cannot not be changed without a shareholder vote.
- Update notification requirements under the name rule to notify shareholders when a fund makes a change to its 80% investment policy by specifying the form and requirements for electronic and written notifications.
- Improve disclosure in fund prospectuses to require a fund to define the terms used in its name, including the criteria the fund uses to select the investments that the term describes. Terms used in the name of a fund that suggest an investment orientation (e.g. ESG orientation) should be consistent with the plain English meaning of those terms or with established industry usage.
- Impose record-keeping requirements designed to give SEC staff and fund compliance staff the ability to assess the fund’s compliance with the names rule. Funds that do not adopt an 80% investment policy would be required to keep a written record of their analysis indicating that such a policy is not required under the name rule.
Compliance policies and procedures
The versions of the Proposed ESG Disclosure Rules and Proposed Names Rule Amendments also set forth the compliance policies and procedures that the SEC would expect with respect to ESG strategies and fund names, including policies and procedures which address the accuracy of ESG disclosures and portfolio management. process to ensure consistent management in accordance with ESG information.
The SEC also suggested specific examples of ESG-related policies and procedures relating to (i) advisers pursuing an integration strategy, (ii) adherence to a particular ESG framework, (iii) the use of positive and/or negative ESG-related screens, (iv) compliance with a client’s ESG-related investment guidelines, mandates or restrictions, and (v) evaluation of ESG-related proxy proposals. ‘ESG.