- securities regulation •
- investment funds •
- Environmental •
- social & governance investing •
- ESG •
- Securities & Exchange Commission •
- SEC •
- Names Rule •
- consumer protection •
- greenwashing •
- mutual funds
As investor money flows into environmental, social and governance (ESG) mutual funds, regulators have raised growing concerns about greenwashing – specifically that a fund’s name will falsely suggest that the fund invests in companies that meet certain ESG standards.
To address these concerns, the SEC proposed amendments to the Investment Company Act “Names Rule.” The amendments extend the scope of the Rule to funds whose names include terms such as ESG, green or sustainable. If adopted, they will require such funds to invest at least 80 percent of the value of their assets in companies that meet the standards suggested by these terms.
We interrogate the SEC’s concern about greenwashing and the extent to which the extension of the Names Rule is rationally directed toward addressing that concern. One challenge is that the term ESG is too broad and imprecise to provide an objective basis for determining which companies appropriately fall within an 80% bucket. A second challenge is that the concept of an 80% requirement is in tension with most mainstream ESG investment strategies. Third and perhaps most problematic, are the limitations of fund names in conveying the extent of information necessary to ensure that a fund meets the expectations of its investors.
We demonstrate these concerns empirically. First, to address the SEC’s concern that investors are not getting a meaningfully different product, we compare the composition of ESG funds with their most closely analogous non-ESG sister funds. Second, through the creation of synthetic Women in Leadership funds, we demonstrate the limitations of fund names in conveying sufficient information about a fund’s investment strategy, even for portfolio criteria that can be measured objectively. Our findings demonstrate that the SEC’s proposal is unlikely to increase investor protection and is likely to impede a variety of legitimate ESG strategies.
We conclude that the SEC’s effort to address greenwashing through the Names Rule reflects an overly simplistic and unworkable approach to characterizing portfolio companies and a narrow perception of plausible ESG investment strategies. Both are at odds with existing market practices and threaten further innovation.