In my new paper for the Climate Risk Disclosure Lab, I examine the different approaches to regulating Environmental, Social, and Governance (ESG) investing in the U.S. and European Union. The rise of ESG has brought significant challenges. The lack of a universal framework for ESG evaluation makes it difficult for investors and other stakeholders to interpret performance across its three domains. Additionally, the phenomenon of “greenwashing,” wherein companies make superficial changes to their practices without genuinely altering their activity, poses a risk to the credibility of ESG initiatives and defeats the purpose of sustainable investing. Moreover, conflicting opinions persist regarding the impact of ESG on financial returns, with some arguing that there is a strong correlation between high ESG performance and financial success, while others point to mixed results.
Recognizing that there is growing investor demand for consistent and comparable information about ESG investment strategies, the SEC proposed two related rules in May 2022, commonly referred to as the “Names Rule” and “ESG Disclosure Rule.” The SEC issued a final Names Rule in September 2023 (the ESG Disclosure Rule has yet to be finalized). These rules are less controversial than the SEC’s other ESG-related rule proposal, the “Climate Risk Disclosure Rule,” which was released in March 2022 and would require public companies to provide detailed climate-related information in their registration statements and annual reports. The proposal has come under intense scrutiny due to its perceived costs of compliance and uncertain benefits (the Climate Risk Disclosure Lab previously published a summary of the nearly 15,000 comment letters submitted to the SEC).
The investing industry has changed considerably since Congress first gave the SEC the authority – in 1996 – to regulate investment company names that could be “materially deceptive or misleading.” The original Names Rule requires funds with names suggesting a specific investment type, industry, or geographic location to invest at least 80% of their assets in the type of investment suggested by their name. However, the emergence of passive investing and ETFs, the use of derivatives, and the rise of ESG led the SEC to conclude that the Names Rule needed an upgrade. The recently amended Names Rule expands the scope of the 80% investment policy requirement by moving from investment “type” to also “include terms in a fund’s name that suggest an investment focus, including a focus in investments that have or whose issuers have particular characteristics.” The rule covers funds with terms like “growth” and “value” in their name, as well as fund names with terms indicating that the fund’s investment decisions incorporate one or more ESG factors.
Beyond updating the Names Rule, the SEC believes more must be done to help ESG investors make informed investment decisions. Therefore, the Commission “proposed amendments to rules and disclosure forms to promote consistent, comparable, and reliable information for investors concerning funds’ and advisers’ incorporation of … ESG factors” on the same day (May 25, 2022) that they proposed an updated Names Rule. The proposed ESG Disclosure rule is unique because it is the first time the Commission has prescribed specific disclosures for a particular investment strategy.
The paper next contrasts the SEC’s attempts to bring greater consistency and comparability to ESG investing in the U.S. with the more aggressive regulatory interventions being pursued by the European Union. The Sustainable Finance Disclosure Regulation (SFDR), the EU Taxonomy for Sustainable Activities, and the Corporate Sustainability Reporting Directive (CSRD), are three comprehensive pieces of ESG-related legislation that apply to wide swaths of the EU economy, not just investment funds and investment advisers. In addition, the European Parliament recently went a step further and proposed specific regulations designed to address the well-known problems with ESG ratings.
While there have been plenty of articles and papers dissecting the SEC’s proposed Climate Risk Disclosure Rule, there has been relatively little written about the Names Rule and ESG Disclosure Rule, and how these rules compare to EU regulations. This paper fills that gap by providing an overview of the final Names Rule and proposed ESG Disclosure Rule, and summarizing the criticism leveled against both proposals from the comment file. The paper then provides additional context around the SEC’s efforts to clean up ESG investing by summarizing the more numerous, and rigorous, ESG-related regulations in the European Union. Click here to read the full paper.
Lee Reiners is a lecturing fellow at the Duke Financial Economics Center (DFE) and directs
DFE’s Climate Risk Disclosure Lab. The author would like to thank Ashley Nelson, Duke
University School of Law Class of 2025, for providing expert research assistance.
