ESG funds plunge, underscoring need for SEC standards, group says

WASHINGTON — A decline in sustainable investments due to current and expected regulatory scrutiny is highlighting the industry’s need for better standards on what qualifies as an environmental, social and governance asset, a top sustainable investing group said.

American sustainable assets under management totaled $8.4 trillion, or about one-sixth of all funds, at the start of 2022, according to a report released by US SIF: The Forum for Sustainable and Responsible Investment.

The 2022 total is less than half the figure reported for 2020, when the organization reported domestic sustainable investments totaled $17.1 trillion.

What changed? US SIF accounted for the steep decline by noting that it altered how it counts investments under the ESG umbrella as regulators around the world demand more accountability from funds claiming their investments are sustainable or promote better social outcomes.

The organization said the Securities and Exchange Commission needs to remain vigilant in that pursuit as the agency finishes rules to avoid greenwashing, a practice by which financial products are made to look more ESG-friendly than they are.

US SIF toughened its standards this year by excluding investments that failed to provide information on distinct criteria used in ESG-integrated funds. The organization instead opted to incorporate assets under management that specified one or more ESG factors into the investment decision-making and portfolio construction and specific funds for which money managers identify ESG or sustainability as integral to investment decision-making in the fund’s prospectus.

“We feel very comfortable with this number and we feel comfortable with our approach,” US SIF CEO Lisa Woll said in a media briefing about the report.

US SIF also cited money managers that reported a modest-to-steep drop in ESG assets under management this year. While the group declined to name specific institutional investors, it said it believes those moves were in reaction to the SEC’s proposal on ESG fund disclosures.

The SEC voted 3-1 in May to propose requiring mutual and exchange-traded funds purporting to consider ESG factors to provide investors information about those factors, their strategies and the criteria used to achieve investment goals. SEC Chairman Gary Gensler said at the time that the proposal will help investors better understand what funds and advisers mean when they claim to be sustainable.

At the same time, US SIF was collecting responses from asset managers on ESG and sustainable investments, said Farzana Hoque, US SIF’s acting director of research. Multiple firms brought up the SEC’s fund disclosure proposal and another proposed rule that would require ESG funds that use names to suggest specific investment types or characteristics put 80 percent of the assets into that investment.

“We had money managers contact us and bring up the SEC issue and ask questions,” Hoque said during the media briefing. “We saw a decline in some of them, not all of them, but multiple money managers did report lower ESG AUM than they did in 2020.

“We think it’s in response to the SEC proposals and money managers trying to be more circumspect or more cautious about how they respond,” she added. “It’s an uncertain regulatory environment.”

US SIF broadly supports the agency’s direction on the ESG fund disclosure rule-making, Woll said. Such rules would allow the United States to play catch-up with other countries.

The European Union last year implemented its Sustainable Finance Disclosure Regulation, which created sustainability disclosure requirements covering a broad range of ESG metrics for financial products. Those regulations have already caused a general decrease in sustainable funds — meaning those financial products are meeting higher standards and actually satisfying investors’ ESG desires, Woll said.

The European Securities and Markets Authority, the EU’s markets regulator, last month proposed quantitative thresholds for the minimum proportion of investments sufficient to support the ESG or sustainability-related terms in funds’ names. The United Kingdom, Singapore and other countries are currently working on similar rule-making to clamp down on misleading funds.

“We don’t know what the SEC will end up actually putting in the rule, but there is no doubt that if they put out some very clear disclosure guidelines … this is a clarion call to those who maybe should’ve been doing a better job of reporting about their processes,” Woll said.

The findings come as Republicans criticize ESG investments and the SEC’s broader approach toward such factors.

Sen. John Thune, R-S.D., led a letter with 11 other GOP senators last week urging President Joe Biden to rethink his “unrealistic” approach toward ESG regulations. The lawmakers accused Biden of overreaching his authority to impose such rule-making, a theme that has come up numerous times in Republicans’ criticism of Democrats’ push to incorporate ESG factors into financial regulations.

“While businesses may elect to pursue their own ESG agendas as part of a free-market society, the heavy-handed imposition from the federal government will have (and in some cases, already has had) negative real-world impacts on our economy and American families, especially by deepening the ongoing energy and inflation crisis,” they said in the Dec. 7 letter.