On May 25, 2022, the Securities and Exchange Commission (the “SEC”) proposed amendments to rules and reporting forms that would require registered investment companies and business development companies (collectively, “Registered Funds”), as well as SEC-registered investment advisers and exempt reporting advisers (collectively, “Advisers”), to provide additional information regarding their incorporation of environmental, social, and governance (“ESG”) factors into their investment processes.1 The SEC explained that the proposal (“Proposal”) comes as a response to increased investor demand for ESG products and strategies as well as significant variation in the way Advisers and Funds define ESG and employ data and criteria as part of ESG strategies.2 The Proposal is designed to promote consistent, comparable and reliable information for investors.
The Proposal would require Registered Funds and Advisers that consider ESG factors in their investment processes to disclose additional information regarding their strategies, with the amount of required disclosure dependent on how important ESG factors are to the particular strategy. In this regard, with respect to Registered Funds, the Proposal specifies different disclosure requirements for three categories of ESG funds: (i) “Integration Funds,” which consider ESG factors alongside non-ESG factors in making investment decisions, but those ESG factors are generally no more significant than other factors in the investment selection process; (ii) “ESG-Focused Funds,” which use one or more ESG factors as a significant or main consideration in the investment selection process or in engaging with the companies in which the fund has invested; and (iii) “Impact Funds,” which are ESG-Focused Funds that seek to achieve a specific ESG impact or impacts. Advisers that consider ESG factors would be required to make correspondingly similar disclosures to those set forth above in their brochures (Form ADV Part 2A) with respect to their consideration of ESG factors in the significant investment strategies or methods of analysis they pursue.
The proposed ESG-related disclosure and reporting requirements for Registered Funds focus on prospectuses, annual shareholder reports, and Form N-CEN. To facilitate investor understanding and comparisons of ESG information, the proposed amendments would create a “layered” disclosure framework, requiring a high level summary in the prospectus supplemented by more specific information in other sections of the prospectus or in other disclosure documents. For example, open-end funds would provide a concise summary of the fund’s ESG strategy in the summary prospectus supplemented by additional detail in the statutory prospectus. Integration Funds would provide more limited disclosures, whereas ESG-Focused Funds and Impact Funds would be required to provide more detailed information in a tabular format, by use of an “ESG Strategy Overview Table” in the applicable Registered Fund’s prospectus. Annual shareholder reports would require certain Registered Funds to disclose additional ESG-related information; for instance, ESG-Focused Funds that consider environmental factors would be required to provide information on greenhouse gas emissions associated with their portfolios. Form N-CEN would require Registered Funds to report information on fund strategies and processes, including information on a Registered Fund’s ESG providers and use of third-party ESG frameworks.
Advisers to private funds and separately managed accounts would be subject to new reporting and disclosure requirements in their Form ADV Part 1A and Part 2A, as applicable. This would include, among other things, categorizing each private fund and separately managed account as utilizing an Integration strategy, an ESG-Focused strategy or an Impact strategy, or alternatively indicating that the Adviser does not consider any ESG factors in making investment decisions. Advisers would also be required to report whether they follow any third-party ESG frameworks in connection with their advisory services, and should consider whether they should make updates to the offering documents of the funds and accounts they advise that are consistent with the additional disclosures in Form ADV.
Further, the Proposal states that the types of ESG strategies used by a Registered Fund or Adviser should be properly reflected in the applicable compliance policies and procedures, and that Advisers and Registered Funds utilizing ESG strategies, including Integration, ESG-Focused and Impact strategies, will necessarily require different levels and types of compliance policies and procedures.
Public comment on the proposed rules is expected to run for 60 days following publication in the Federal Register.
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If you have any questions regarding the information discussed above, please contact your Investment Management Group attorney at Seward & Kissel LLP.
