The SEC’s Misguided Fight Against Greenwashing

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So-called greenwashing by asset managers misleads investors by labeling products with false claims of environmental, social and governance (ESG) benefits. But the SEC’s initiative to restrain this malpractice falls short because it does not distinguish between risk- and ethics-driven ESG products.

For all the challenges ESG investing faced in the past year – from pushback by large institutional investors to anti-ESG legislation in certain states – one bright spot was increased attention to greenwashing by U.S. regulators. The SEC introduced several new initiatives in 2022 designed to increase transparency and disclosures around ESG. For investors skeptical of the greenwashing that has discounted the ESG movement, this new government regulation is a strong force for good in helping advisors and their clients regain trust.

One of these recent initiatives included an SEC proposal that would provide structure around the use of ESG labels in investment products and strategies. More specifically, it would regulate funds and advisors claiming to achieve a precise ESG impact and require them to describe the specific goals they seek to achieve and summarize their progress. According to SEC Chair Gary Gensler, “This gets to the heart of the SEC’s mission to protect investors, allowing them to allocate their capital efficiently and meet their needs.”

The proposal has the potential to create labels and require disclosures that ultimately provide clarity to investors, but the main issue is that it fails to make the distinction for investors about the why. Is the fund investing in ESG to minimize business risk for financial outperformance (business risk-driven) or to support the companies that are changing humanity for the better (ethics-driven)? Without this important distinction, investors with ethical concerns may be duped into investing in ESG products that only aim to minimize risks for financial reasons versus doing the right thing. This results in a critical mismatch between the goals of the fund and the investor.