New regulations governing sustainable investing in the European Union could affect U.S. investors soon.
This week, new EU rules took effect for managers of sustainable funds—or those that invest according to environmental, social or governance (ESG) considerations. Now these fund managers must report specifics of how they do their investing. The EU’s Sustainable Finance Disclosure Regulation, or SFDR for short, affects all asset managers that raise money in the EU, even if they are not based there. That means the new regulations have implications even for those funds offered to U.S. investors.
The rules are aimed to prevent so-called greenwashing, or funds being marketed as sustainable when they are only superficially so. Among other things, money managers in the EU must classify their funds either as non-sustainable; as owning investments with particular environmental or social characteristics; or as contributing to a specific environmental or social objective. This will require changes to disclosures and marketing materials, with money managers needing to report how they assess their companies across a range of metrics. The detailed disclosures must be supplied beginning in 2022.
Amy O’Brien, global head of responsible investing at U.S.-based Nuveen, say s her firm, which oversees $1.2 trillion in assets, is very involved with SFDR. “It’s no longer just about disclosing ESG information, but also about how you’re using it to pursue specific ESG objectives,” she says. And the eventual result is that “more power is in the hands of the end investor.”
The new EU rules come amid a flurry of ESG-related regulations in the U.S.
The Securities and Exchange Commission has said it will increase examinations of asset managers to make sure their statements to shareholders align with their strategies. It is also checking to see how ESG funds vote on environmental matters in shareholder proxies, and if they are consistent with environmentally friendly policies.
“There will be more and more demand for verifiable, reportable actions,” says David Sand, chief impact strategist for Community Capital Management, a longtime sustainable investor. “We’d love for there to be standardization and for people to have to prove” that their portfolios are sustainable.
In addition, starting next month,
said it will start to collect information on funds that identify themselves as green, and provide them to users. With many global investment managers marketing almost identical funds in the U.S. and in Europe, U.S. investors can look up the Morningstar information for the European version of their fund to see how well it is sticking to its ESG mandate. “You’ll see this [the influence on U.S. investors] as early as next month,” says O’Brien of Nuveen.
Greenwashing in the mutual-fund industry has been a concern among investors, especially given the steep increase in sustainable investments. Money has flooded into the category. U.S.-domiciled sustainable investments totaled $17.1 trillion at the beginning of 2020, up 42% from two years earlier, according to US SIF, the trade group for the sustainable investing industry. That number represents about a third of U.S. assets under management.
“The European rules are the first attempt to go after greenwashing,” says Bryan McGannon, director of policy and programs for US SIF. “It will start the conversation in the U.S.”
Firms will attempt to distinguish themselves by having more robust disclosures around the way they apply ESG investing. Because so many firms in the U.S. also offer funds in Europe, this could raise the quality of sustainable investing in the U.S., similar to the way auto manufacturers improved their emissions as California introduced tighter requirements than those issued by the federal government.
Already, more U.S.-based fund managers are issuing impact reports detailing proxy voting and engagement, and the net impact of their holdings, says Jon Hale, global head of sustainability research at Morningstar. “This is an emerging best practice,” he says.
Aside from the SEC, the Labor Department is creating a friendlier environment for sustainable investing. The department has said it won’t enforce two controversial Trump-era rules that would have dragged on the adoption of sustainable funds, including one that would make it harder to include them in 401(k) retirement plans. The DOL is key to America’s retirement plans because it administers and enforces the Employee Retirement Income Security Act of 1974, or Erisa, which protects the interests of employee benefit plan participants and their beneficiaries.
The flurry of new rules mean investment managers need to step carefully, experts say. “Managers working to implement the [EU] disclosure requirements should continue to make sure that any new disclosure on nonfinancial goals is not written in a way that may create issues for fiduciaries under the [Labor Dept.’s] approach to ESG,” Ropes & Gray partner
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