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Friday Letter: SEC is right to tighten up on ESG claims

The SEC’s proposals to require a kind of 'truth in advertising' around ESG funds are a good first step.

ESG, planet, environment

VCs are quick to speak up when they feel like the government is overreaching. So I was prepared to get an earful about the SEC’s recent proposals to require a kind of “truth in advertising” around ESG funds. Instead, what I heard were mostly supportive comments.

The regulator has put forth two proposals that aim to prevent misleading or deceptive claims about environmental, social and governance practices by US funds and increase the amount of ESG information those funds disclose to their investors. The new rules would affect both public and private funds. Yes, that includes VC funds, most of which are lightly regulated by the SEC because most VCs are exempt reporting advisers.

“I think the proposals are a great thing for the venture industry,” said Nancy Pfund, founder and managing partner of DBL Partners. “Will they be great for every fund? No, but that is the point!”

DBL, founded in 2002 and based in San Francisco, is among the first venture firms focused on impact investing. “What’s helpful about the proposed SEC rules is that they aim to support and set apart funds that take sustainability and ESG seriously – those that ‘do the work’ – from those that greenwash or otherwise obscure the degree of ESG engagement they really have,” Pfund told me.

The SEC proposals also got a thumbs up from Wes Selke, co-founder and managing director of Better Ventures, an impact investor based in Oakland and founded in 2010. “I support the SEC’s move to add some teeth to firms’ ESG reporting given how popular this investment strategy has grown in recent years and how important ESG is to so many retail investors today,” Selke told me. “Given how many firms have jumped on the ESG bandwagon in recent years, it’s important that they’re able to demonstrate that their actions support their rhetoric.”

The new rules come as a growing number of funds label themselves “green,” “sustainable,” “low-carbon” and so forth to appeal to investors that care about environmental, social and governance issues. In a statement about the proposals, SEC chairman Gary Gensler estimated that the “US sustainable investment universe” is comprised of “hundreds of funds and potentially trillions of dollars under management.”

“When an investor reads current disclosures… it can be very difficult to understand what some funds mean when they say they’re an ESG fund,” Gensler said. “There also is a risk that funds and investment advisers mislead investors by overstating their ESG focus.”

To make sure funds are what they say they are, the SEC wants to implement a few changes. One change would extend its Names Rule to more funds. The current rule requires registered investment companies that have names suggesting a focus on a particular type of investment to invest at least 80 percent of their assets in those types of investments.

The SEC wants to extend the Names Rule to “any fund name with terms suggesting that the fund focuses in investments that have (or whose issuers have) particular characteristics,” according to an SEC statement. “This would include fund names with terms such as ‘growth’ or ‘value’ or terms indicating that the fund’s investment decisions incorporate one or more environmental, social or governance factors.”

In other words, if I launch a fund called Climate Technology VC, then at least 80 percent of that fund’s investments should be in companies focused on climate technology.

The SEC’s proposal around fund names may need a bit of refining, Pfund said. “My biggest hope would be that the SEC takes the approach of working with the industry to absorb feedback and work with the industry to build the requirements over time,” she said. “Regarding the 80/20 rule, we believe it needs revising to take into consideration the role of multi-dimensional impact in fund construction. Our experience has been that this approach is a powerful driver of return and positive ESG performance.”

Selke can’t help but feel a little wary of the proposed changes because they’re coming from the government. “My hope would be that the SEC can get this right and not just add a layer of regulation that makes our work harder without actually moving the needle on ESG reporting,” he said. “I’m in favor of the emergence of a GAAP-style set of ESG reporting metrics at some point in the future, and I know there are groups working on supporting that including B-Lab and the Global Impact Investing Network.”

It is also worth noting that the SEC’s efforts advance ESG efforts only so far. There is much more work to to.

“Without standardization of metrics and benchmarking, instituting disclosures can provide more transparency, but will require LPs to become the experts across all three pillars, environmental, social and governance,” said Tracy Barba, head of ESG and global stakeholder development for 500 Global, an early-stage firm based in San Francisco.

“Additionally, ESG integration into venture fund strategies can vary by stage, sector and geography,” she added. “So, while disclosures can enable accountability and transparency, without guidance on what is ‘good,’ you end up with more data but not necessarily more clarity on what strategies are generating the best returns and ESG outcomes.”