Are higher profits or stable growth a priority when you invest? The companies you support can vary significantly across the board, but you can have your own preferences in specific sectors. You may even have a set of rules that you abide by when investing. Would you support a company that cuts down trees to develop a casino? Trees are necessary to ecosystems, and casinos facilitate people’s gambling addiction. In the last two decades, ESG investing, a framework to support a conscientious way of investing, has become more readily accepted.
ESG is an acronym for environmental, social, and governance. It promotes a more responsible way to invest. The idea behind ESG originated in the twentieth century, deriving from an earlier form of responsible investing. ESG allows investors to consider a company’s profits and performance and its impact on the environment, society, and corporate governance.
In the United States, the Securities and Exchange Commission (SEC) was formed in 1934, after President Franklin Roosevelt signed the Securities Act, giving investors and markets reliable information and preventing unfairness. The SEC regulates securities like the stock markets and investing firms. In recent years, the SEC has also taken on a more active role in regulating ESG, which still has many outstanding problems.
In the past, socially responsible investors sacrificed profits over sustainability. However, ESG also helped investors to avoid investing in shady companies with risky practices. While it may be a sustainable investing strategy, ESG is still ridden with many issues like discrepancies in ESG ratings.
Many companies have an ESG policy but choose what ESG actions they disclose. The disclosures are rated by other agencies, like MSCI (Morgan Stanley Capital International), which produce conflicting ratings. The rating agencies’ decisions can affect the stock market and the companies they evaluate stand to benefit from a positive rating. The issue is that ESG ratings rely on information reported by a company, and these businesses don’t always provide the full picture. Overall, the issue is that ESG scores from different rating agencies conflict as they determine scores differently.
A bigger issue is the names of securities like mutual funds and exchange-traded funds (ETFs). The SEC has required investment companies to invest at least 80% of their assets in the investments that are suggested by fund names, also known as the Names Rule. Even so, many fund names are inaccurate. For example, many funds with “ESG” in their names can mislead investors. This means that ESG-named funds may not always follow ESG practices, but operate in unethical ways. More importantly, these types of funds usually result in lower value and growth.
Recently, the SEC is proposing to amend the Names Rule. As described above, fund names are a loophole for companies to masquerade as ESG-abiding companies while taking advantage of investors. The SEC’s proposal would make other funds abide by the Names Rule for any fund name with particular traits like “value” or “growth.”
Another proposal the SEC has put forward regulates corporate reporting. This proposal would compel companies to specify their ESG practices and describe the impacts they claim their practices make. Companies would also send their ESG reporting to the SEC. Thus, this proposal would ensure greater transparency in ESG practices to the SEC and investors.
Together, both of the Commission’s proposals seek to regulate ESG-related matters more tightly. In this way, investors can benefit from having more transparent corporate information to make wise investing decisions.
By far, ESG is a noble idea but is still being regulated and modified. Two major issues are the misnaming of funds and the lack of transparency by companies. Fund names can be deceptive on the surface and may not be as socially responsible as they claim. By the same token, companies may choose to obscure their ESG reporting as specifically or vaguely as they like. All in all, the SEC’s two proposals are poised to deal with both issues and protect investors’ interests.