Mutual Fund Disclosures: Regulators Focus on Foiling Greenwashing in Global Markets
Europe leads, while Asia plays catch-up and the U.S. lags.
Worldwide, much environmental, social, and governance regulation has been introduced, or is in the pipeline, that will require more-standardized disclosure to inform investors’ understanding and comparison of investment products. This should help prevent greenwashing—or using ESG claims in fund marketing without ESG principles truly guiding investment decisions—from being a significant issue for investors. Similarly, financial regulators increasingly expect asset managers to disclose to their investors their approaches to stewardship.
In the Global Investor Experience Fund Disclosures update, we assess the environment for mutual fund investors in markets around the world, identifying new and enhanced disclosure practices and markets that need to improve to align with global best practices. While ESG and stewardship disclosure have been in the spotlight, the demise of Silicon Valley Bank and the wipeout of Credit Suisse’s hybrid securities highlighted the critical importance of portfolio holdings disclosures and the need for enhanced efforts in some markets. Here’s what we’re seeing.
Updates to the GIE Disclosure Landscape
We’ve found that the United States remains a leader in mutual fund disclosure best practices for portfolio holdings and manager details and is not resting on its laurels. Revised rules to tailor shareholder reports to modern-day investors are scheduled to take effect in 2024, and ESG disclosures are under consideration.
Since our last GIE Disclosure report, the U.S. Securities and Exchange Commission has consulted on and finalized major changes to the disclosures that mutual fund investors receive. The primary change will see a new, concise annual report that is visually engaging and presents important information in an easy-to-read format. The SEC also proposed a significant change to the way mutual funds and advisors describe their use of ESG factors in their investing.
The updated shareholders reports will include information on the fund’s performance, material changes, principal risks, and other appropriate information that will improve transparency and accessibility for shareholders, although we think there were opportunities to go further.
Morningstar believes investors would be better served by an intermediate time horizon between the one- and 10-year performance returns that will be required, and that returns need to be properly benchmarked. The SEC’s limitation of benchmarks to broad-based indexes is unsuitable for many investment strategies, such as funds focused on value stocks, multi-asset strategies, and target-date funds.
We also see further opportunity to enhance transparency in fee disclosures for investors. For example, we believe the annual report should alert investors to whether any payments are made to intermediaries for research or distribution. This disclosure benefits shareholders by alerting them to the presence of fees that may create a conflict for the financial intermediary with which they work and soft-dollar fees that may indirectly reduce their returns. Additionally, funds should be required to report detailed information about these fees.
5 Takeaways From Our Global Investor Experience Disclosure Update
1) Europe remains the region with the most prescriptive and extensive ESG disclosure requirements, encouraging asset managers to substantiate their products’ objectives and ESG performance, though leading the way is not without its challenges. Counterbalancing the volume of information and its prescriptive nature with how best to make it comprehensible is an aspect that other markets are developing their own approaches to. In a still relatively nascent domain, a regulatory openness to the continued evolution of reporting requirements is to be encouraged.
2) Asian markets have also been busy introducing ESG-related regulations to provide more standardized disclosure. In June 2021, the Hong Kong Securities and Futures Commission issued a new circular to further enhance disclosure for ESG funds, including additional guidance for funds with a climate-related focus. In July 2022, the Monetary Authority of Singapore released a circular detailing requirements for retail ESG funds and the disclosure and reporting guidelines applicable to these funds. In March 2023, a Korea Financial Supervisory Service task force launched ESG fund disclosure criteria, promoting the establishment of disclosure standards to resolve investor information asymmetry and induce responsible investment management. India, Thailand, and Taiwan have also introduced ESG disclosure standards. These are positive changes for Asian investors, but it remains too early to tell how effective these regulations will be in helping retail investors make more informed decisions when investing in ESG funds.
3) Perhaps the most significant change implemented since our last mutual fund disclosure report is the replacement of the UCITS Key Investor Information Document, or KIID, by the PRIIPs Key Information Document, or KID. KIIDs have been published since 2010 and, in our view, ticked many of the best-practice boxes of a short-form or simplified prospectus. The KID aligns UCITS disclosures with those of many disparate retail investments, including unit-linked insurances, structured products, and corporate bonds. Achieving consistency comes at a cost, including a new risk indicator that blends both market and credit risk, as well as the replacement of past performance data with new performance scenarios, although a late acquiescence requires funds to signpost investors to KIID-like performance disclosures separate from the KID.
4) Unlike the incremental piecemeal approaches to change that regulatory environments usually demand, the U.K. Treasury and Financial Conduct Authority potentially have a once-in-a-generation opportunity to build a truly cohesive disclosure framework that gets decision-useful information to investors in an engaging, understandable, and easy-to-consume manner. In the environment after Brexit, freed from the constraints of EU regulation, the United Kingdom has commenced a raft of changes that touch on disclosure. Given the opportunity to evaluate existing practices and to make significant change to the current regulatory environment, this market will offer an interesting case study in the coming years.
5) There are still notable laggard markets, such as Australia, that have neither dealt with existing basic deficiencies in their markets’ fund disclosure practices nor adapted to changing investor expectations around ESG and stewardship disclosure. Australia blew a chance to improve its portfolio holdings disclosure regulations in November 2021 when, after drafting median global standard regulations, the government caved in to lobbying from vested industry interests to deliver what are essentially meaningless asset-allocation disclosures. Australia stands alone as having clearly the feeblest disclosure regime among the 26 markets in Morningstar’s GIE study universe and a lack of political will to implement meaningful change.
The importance of timely reporting on portfolio holdings disclosures was recently in the spotlight with the collapse of Silicon Valley Bank and the wipeout of Credit Suisse’s hybrid securities. Fund investors in markets with best practice disclosures had a relatively clear picture of their exposures. Fund investors in markets such as Australia were left in the dark as to what their exposure to these securities may have been.
A Look at the Road Ahead for Disclosures
Providing investors with more information than ever comes with a risk that disclosures intimidate more than engage. There remains considerable scope to improve the presentation and delivery of disclosed information to make it more accessible, understandable, and engaging for end investors. Increasing technology uptake heightens investor expectations around the information that should be disclosed and at what frequency and in what formats. Regulators such as those in the U.S. and U.K. are actively considering how technology can further improve disclosures to investors.
From Morningstar’s perspective, the best regulatory approach is rooted in greater transparency, which helps investors make better decisions and creates trust in the vehicles used for investment and the firms that manage client assets. In the long run, mutual fund industry stakeholders that fight transparency are likely to generate outcomes that are bad for investors and bad for the industry itself.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.