In our previous articles (Lack of Uniformity in ESG Ratings System Poses Risks and Opportunities, ESG Regs Abroad Offer Road Map For US Multinational Cos. & ESG Enforcement Risks: From “Greenwashing” to “Wokewashing”), we recommend that public entities begin re-visiting their ESG-related practices and policies in light of the expected ESG public disclosure amendments from the SEC. Although there has been significant pushback against the ESG movement that will likely lead the SEC to temper some of its proposed amendments, we expect some features to remain intact after the enactment of the amendments. One of these features will likely relate to the definition and fundamental characteristics of various ESG funds. This post examines the anticipated disclosure requirements below based on the category of an ESG fund.
What is an ESG fund?
In its proposal, the SEC explains that “ESG is an expansive term that incorporates three broad categories of interest for investors and asset managers: environmental issues, social issues, and governance issues. . . . Some funds and advisers will consider only one issue under the ESG umbrella when making investment decisions, while others will apply the factors more broadly and implement measures across each of the ESG categories.” The SEC proposes to distinguish between the funds and require them to make their disclosures based on their degree of commitment to ESG investing. Depending on that commitment, the SEC broadly categorizes funds into four categories: Integration Funds, ESG-Focused Funds, Impact Funds, or Unit Investment Trusts (UITs). The categorization will help funds tailor their disclosures to the level of their commitment to ESG investing, which in turn will help investors make their investment decisions.
For example, the Integration Funds are those funds that consider at least one ESG factor as well other non-ESG factors. These funds will have the least stringent ESG disclosures compared to more committed ESG funds. An Integration Fund will need to briefly disclose what ESG factors it considers and how it incorporates those factors into its investment selection process. The ESG factors will not be determinative or predominating in an Integration Fund. The fund will need to disclose in its prospectus its Greenhouse Gas (GHG) emissions information if it considers them as an ESG factor in its investment strategy. “This disclosure must include a description of the methodology that the fund uses as part of its consideration of portfolio company GHG emissions.” To illustrate, a fund “might disclose that it considers the GHG emissions of portfolio companies within only certain ‘high emitting’ market sectors, such as the energy sector.” This fund will be required “to describe the methodology it uses to determine which sectors would be considered ‘high emitting,’ as well as the sources of GHG emissions data the fund relied on as part of its investment selection process.”
By contrast, an ESG-Focused Fund will need to disclose the information related to the GHG emissions in a more elaborate manner than an Integration Fund unless it disclaims that it considers these emissions in its investment selection process. For instance, in the absence of the disclaimer, an ESG-focused fund will need to disclose the carbon footprint and the weighted average carbon intensity of the fund’s portfolio. An ESG-Focused Fund is a fund that focuses on one or more ESG factors in its investment strategy—be it in selecting ESG investments or investing in ESG companies. These funds would, for instance, track an ESG-focused index or rely on a system that sifts through investments in various industries based on ESG factors. Any “fund that markets itself, whether through its name or marketing materials as having an ESG focus, would be required to provide the proposed ESG Strategy Overview Table” the SEC specially developed, and which is copied below as Table A.
The SEC proposed to include Impact Funds into the definition of an ESG-Focused Fund. Impact Funds, however, will have an added characteristic—they will have a specific ESG impact they aim to achieve. An example of an Impact Fund is a fund that invests to improve the availability of clean water. These specific purpose funds will have additional disclosure obligations. The managers of these funds must describe how they measure their funds’ progress towards a given impact, during what period they seek to achieve the progress, the connection between the impact and the financial return on the investment, and the main factors that materially affected the fund’s achieved impact.
Table A – ESG overview table for ESG-focused funds, including impact funds: 
The proposed rules similarly include an amendment to the registration statement requirement for UITs to explain how portfolios are selected based on ESG factors. Specifically, the statements must disclose how those factors were used to select the investment portfolio. The unmanaged nature of UITs is the reason the proposed rules do not require UITs to follow an integration model or an ESG-Focused model.
For any fund that uses proxy voting to implement its ESG strategy, such fund will need to disclose how it voted proxies relating to portfolio securities on ESG issues during the reporting period.
While the proposed amendments will likely change to some extent, one fact remains certain—some ESG disclosure rules will begin to finalize as soon as April 2023, according to the SEC’s 2023 Regulatory Agenda, which will provide guidance on potential updates and changes that funds should consider to reflect in their ESG investment practices disclosures. The guiding principle behind any companies’ ESG disclosures should always center on accuracy, truthfulness, and completeness.
But the funds should not wait until the enactment of the amendments to begin preparing their compliance. Companies should be contemplating what they can do now to adjust their policies and procedures to comply with the SEC’s proposals as they currently exist. Undoubtedly, the compliance burdens of the companies that have begun incorporating some of the amendments will be less onerous. To this end, companies should form internal ESG-compliance teams that would include, among others, ESG-savvy comptrollers, marketers, in-house counsel, and outside litigation attorneys.
The SEC proposed amendments to rules and reporting forms on May 25, 2022. To provide adequate adjustments in the market, the SEC suggested a one-year grace period from the effective date of any final rulemaking for compliance with the prospectus disclosures and regulatory reporting on Form N-CEN. Additionally, the SEC suggested an 18-month grace period to comply with annual report disclosure requirements. The SEC also invited public comments on its proposals.
There is a plethora of comments on the SEC’s website in response to the invitation, ranging from concerned citizens, universities, Members of Congress, companies, trade association, and other entities. Comments unfavorable to the proposed amendments question the SEC’s authority to propose this rulemaking, arguing that any authority to pass any security law is vested in Congress as opposed to the SEC. These comments are predominantly concerned with how the proposed amendments may restrict domestic energy production and raise energy costs, as well as the costs incurred to companies to implement the proposed amendments and how those costs will ultimately pass to the investors. The naysayers also doubt the scientific substantiation behind the idea that carbon emissions pose risks for the environment and must be reduced.
Those who accept the proposed amendments laud their anticipated increased transparency to investors and the positive impact on the corporate practices anticipated to stem from companies’ transition into becoming ESG-friendly.
Once the SEC’s proposed disclosure framework is enacted, Squire Patton Boggs (US) LLP’s team will be sure to bring you up to speed and provide you with useful commentary. Stay tuned.
 SEC, Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices,p. 13, https://www.sec.gov/rules/proposed/2022/ia-6034.pdf.
 SEC, Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices,p. 28, https://www.sec.gov/rules/proposed/2022/ia-6034.pdf.
 SEC, Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices,p. 34, https://www.sec.gov/rules/proposed/2022/ia-6034.pdf.
 SEC, Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices,p. 36, https://www.sec.gov/rules/proposed/2022/ia-6034.pdf.