The US Securities and Exchange Commission has proposed new rules aimed at better aligning the names of investment funds with their underlying strategies.
The SEC has proposed new rules designed to prevent investors from being misled by inappropriately named funds.
The current rule regarding fund naming practices, designated Rule 35d-1 of the Investment Company Act of 1940, was introduced in 2001.
It requires investment funds registered under the Act, which includes most ETFs, to dedicate at least 80% of their assets to securities that are appropriate for the strategy implied by the fund’s name.
While the SEC always cautioned investors to investigate beyond a fund’s name, the rule recognized the importance of fund names in conveying information to the investor and, therefore, offered significant leeway in its application.
Notably, the rule has only been applied to geography, sector, and industry exposures suggested by a fund’s name.
According to the SEC, however, the rapid evolution of the fund management industry over the past two decades, which has seen the proliferation of a diverse range of socially responsible, thematic, and factor-based investment strategies, has necessitated a review of the existing naming rules.
The SEC notes that increasingly competitive market pressures have created incentives for asset managers to include certain terminology in their funds’ names in order to attract investor assets.
Making specific reference to ‘green’, ‘sustainable’, and ‘low carbon’ investment products, the SEC has proposed expanding the current 80% rule in order to stamp out greenwashing (a form of marketing spin in which deceptive tactics are used to exaggerate an organization’s environmental and social characteristics) and protect investors from being misled by inappropriately named funds.
In tandem with tightening fund naming rules, the SEC has also proposed requiring enhanced prospectus disclosures and additional reporting standards for funds to maintain compliance with the new naming regulations.
Gary Gensler, Chairman of the US Securities and Exchange Commission, noted in a press release: “It is important that investors have consistent and comparable disclosures about asset managers’ ESG strategies so they can understand what data underlies funds’ claims and choose the right investments for them.”
According to Gensler, the SEC’s proposed framework for disclosures regarding ESG funds and strategies can be outlined in three steps.
Firstly, all funds referencing ESG must disclose in their prospectuses what ESG factors they consider, along with the strategies they use. This may include whether certain types of assets are excluded, if and how proxy voting or engagement is used to achieve certain objectives, or how the fund aims to make a specific impact.
Secondly, ESG-focused funds, defined as those that employ ESG factors as a main aspect of their investment strategies, would need to disclose details about the criteria and data they use to achieve their investment goals.
Finally, certain ESG-focused funds would also be required to disclose relevant metrics. For example, low carbon funds would be required to report the greenhouse gas emission metrics of their portfolios, while impact funds would be required to disclose metrics related to the annual progress made toward their ESG goals.
Market participants have 60 days from the publication of the SEC’s proposals in the federal register to return their comments for consideration. If the SEC decides on passing any current or amended proposals, asset managers will have a period of one year to bring their funds into alignment with the new rules.