ESG Regulation: Coming Up or Catching Up?

0:43 – What Do We Mean by ESG Regulation?

Top of mind is the SEC’s proposed rule, which requires mutual funds to disclose how they incorporate environmental, social, and governance factors. Aron expects there to be changes between the proposed rule and the final rule, which makes it difficult for advisors to know what to expect. If the final version sticks to the current framework, advisors will need to be able to explain how ESG funds engage in different activities and align with investors’ values and risk profiles.

3:35 – The Advantage for Advisors

According to Aron, ESG regulation is playing catch-up. Many investors are very interested in using ESG in their investing process, whether to avoid ESG risk, pursue goals, or something in between.

Regulation isn’t driving this interest—it’s catching up to it and trying to ensure some consistency, comparability, and comprehensiveness across disclosures so investors can accurately compare funds and companies. Over time, advisors who are fluent in that language will have an advantage over advisors who aren’t.

7:07 – Playing the Comparison Game

According to Bryan, US SIF advocates for treating sustainable investing like any other strategy or data set. However, they have seen regulatory interest in sustainable investing grow substantially in the past few years. Aron says that one unusual aspect of ESG regulation is the amount of technical information agencies have had to acquire. All public policy work is interdisciplinary to some extent, but especially the ESG ecosystem.

12:28 – More Regulation, More Cost?

Economic analysis is a part of drafting new regulations. While fund managers may incur costs if they decide to redesign or reposition their funds under the new regulation, Bryan doesn’t think that ESG regulations themselves should force a significant expense onto asset managers.

14:40 – Improving ESG Regulations

Due to the complexity of ESG regulations, constructive commentary from the industry is not only expected, but helpful for reducing investor confusion. Generally, US SIF members want to simplify the proposed regulation. Their perspective is that the current draft uses three buckets that don’t map well to how the marketplace operates. US SIF recommends that all funds claiming to be sustainable or ESG-oriented should disclose key information so investors can have consistent data points to compare funds.

Similarly, Aron observes that activities like ESG risk avoidance are not currently captured well in the buckets suggested by the SEC. He also thinks that the proposed integration category is too broad and could potentially mislead investors.

18:51 – Stakeholders That Influence Regulators

ESG regulation touches many areas, and so many have filed comment letters in response to the latest rule. Active associations represent issuers, the mutual fund industry, the sustainable investing field in the U.S., nonprofit advocates for issues like climate policy or human capital, and more.

Aron notes that Congress will play its constitutional role of providing oversight and asking questions, especially because ESG can be a controversial and polarizing issue. However, at the end of the day, the real decision maker is the chair of the SEC and the two other appointees, who have the three votes they need to promulgate this regulation. In the end, this process doesn’t require consensus.

22:02 – Political Noise Influencing Investor Behavior

As ESG activities, particularly managing ESG risk, become more mainstream for professional investors, there’s a danger of sustainability becoming heavily politicized. Both sides of the aisle may benefit from making ESG regulation a voter's issue.

But ESG is a complex topic that requires continuous learning—it should neither be superficially dismissed nor superficially embraced. At its best, ESG regulation should help ordinary people understand the material impact of ESG factors on their investments.