Green still grey area for ESG investors despite mounting scrutiny by watchdogs in U.S. and Canada

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Regulators in Canada and the United States are pushing ESG funds to disclose more information to weed out “greenwashing” and other misleading practices, but a lack of standardized terms and metrics mean those buying the funds must still be wary, investor advocates say.

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The latest attempt to separate marketing pitches from strategies that truly fulfill environmental objectives come via the U.S. Securities and Exchange Commission, which last week proposed rules that, among other things, crack down on whether fund names accurately reflect the underlying strategy.

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Those marketing their funds with a focus on environmental, social or governance objectives would have to invest at least 80 per cent of their assets to that end, according to the proposal. Funds would also have to disclose information about the emissions of companies they hold, and how they measure their progress against stated goals, in their communication with investors through fund prospectuses, annual reports and adviser brochures. 

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Canadian regulators, too, have been focused on identifying greenwashing in the fund business. Last year, the Canadian Securities Administrators, an umbrella organization for the country’s provincial and territorial market watchdogs, oversaw a wide-ranging review of the marketing, regulatory disclosure and sales communications of funds whose investment objectives reference ESG strategies. 

Following the review, which found that more than half the funds scrutinized “lacked detailed disclosure in their investment strategies about the specific ESG factors considered by the fund,” the CSA issued fresh guidance to the industry in January.

The CSA review also uncovered a widespread failure to disclose how ESG factors were evaluated, and more than a third of the funds reviewed held investments in industries that should not have been permitted by their exclusionary investment strategies. Further, about one-fifth of the funds reviewed had portfolio holdings that appeared to be inconsistent with the fund’s name, investment objectives or investment strategies.

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The guidance introduced this year “aims to bring greater clarity to ESG-related fund disclosure and sales communications to enable investors to make more informed investment decisions,” said Ilana Kelemen, a spokesperson for the CSA.

The essential problem is that the world still lacks accepted, standardized metrics for ESG — so for the time being, ‘green’ is grey

Neil Gross, a veteran securities lawyer and investor advocate

Still, with a growing number of ESG-marketed funds and no strict or uniform criteria for what they must accomplish on social, environmental or governance issues, investment advocates and environmental groups don’t expect a one-size-fits-all solution.

“The essential problem is that the world still lacks accepted, standardized metrics for ESG — so for the time being, ‘green’ is grey,” said Neil Gross, a veteran securities lawyer and investor advocate.

The responses from regulators on both sides of the Canada-U.S. border seem to back up the notion that they have a limited role to play for now, putting the emphasis on beefing up and policing disclosure requirements rather than writing new rules and enforcing a specific code.

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“Regulators can and should help us to separate the meaningful from the marketing, by requiring more complete disclosure from fund managers about the elements and depth of their approach,” said Kevin Thomas, chief executive officer of the Shareholder Association for Research and Education (SHARE).

“What they can’t do is to regulate what constitutes the one, true, ESG strategy, because those strategies vary widely and are regularly being tested and updated as we learn more about what’s needed and what works.”

With no new rules on the books in Canada, it will be up to individual provincial and territorial regulators to determine when and where enforcement action is warranted, according to Gross.

The CSA noted that its review of 32 funds, managed by 23 different investment fund managers, was intended to gauge how existing disclosure standards including “full, true and plain disclosure of all material facts” were being applied to funds that referenced ESG in their investment objectives or strategies or marketed themselves in online sales communications as ESG-related funds.

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The umbrella group also noted that some of its findings were observational, rather than strictly related to compliance with disclosure requirements.

The SEC rules on ESG-related disclosure proposed last week are open for a 60-day comment period and aren’t expected to be finalized for several months, but that hasn’t stopped regulators from taking action in specific cases. 

Earlier this month, the SEC imposed a first-of-its-kind fine of US$1.5 million on the investment advisory arm of BNY Mellon in a settlement over allegations of misstatements and omissions related to information about ESG investment criteria for its mutual funds between July 2018 and September 2021. Before the settlement, the regulator had alleged that while various fund statements suggested all investments in the funds had undergone an ESG quality review, this was not always the case.

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Regulators aren’t alone in pushing for greater transparency and uniformity when it comes to climate-related activity, and funds aren’t the only target. In Canada’s spring budget, for example, Justin Trudeau’s Liberal government pledged to require big banks to disclose climate-related financial risks. 

The Office of the Superintendent of Financial Institutions (OSFI) is now consulting with banks and other federally regulated financial institutions on climate disclosure guidelines that will adhere to the global Task Force on Climate-related Financial Disclosures framework.

And separate from the review that led to fresh guidance for the fund industry in January, the CSA has sought input on how a wider range of companies should disclose climate-related risks, opportunities and financial impacts to address concerns disclosure is not complete, consistent, or comparable. The regulator said tackling these issues would improve access to global capital markets in part “by aligning Canadian disclosure standards with expectations of international investors.”

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The comment period ended in February, and the CSA’s Kelemen said staff are reviewing the comments received, as well as rules proposed by the SEC and disclosure standards proposed by the International Sustainability Standards Board. They will then make recommendations for “a final form of rule” to the provincial and territorial securities regulators that are members of the CSA.

Some, including the Ontario Securities Commission, already appear to be preparing to beef up requirements, Gross said.

“A year ago, OSC and BCSC (British Columbia Securities Commission) staff began sweeps to assess the general accuracy of ESG claims,” he said, adding that the OSC laid out plans to further consult and develop rules for companies on climate-change disclosure in the regulator’s statement of priorities for 2022-23.

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