In October, during the final throes of the Trump presidency, the U.S. Department of Labor (DOL) finalised a rule clarifying that fiduciaries of private-sector retirement and other employee benefits plans must put beneficiaries’ financial interests first when deploying capital, rather than other “non-pecuniary goals and policy objectives” which was deemed to include environmental, social and governance or impact related goals.
This was part of a multi-pronged attack on ESG investing, which also included potential limitations on pension plans’ voting power at a corporate level and restrictions on employees joining an ESG focused pension fund.
However, the change of guard at the White House has led to a number of notable policy pivots in the U.S. government.
First, the freshly-staffed DOL wasted no time in issuing a notice that they will review rules created during the Trump era that opposed the new Biden administration’s stance on the environment and other social matters. The department promised guidance on the subject and until such guidance is issued, the DOL won’t enforce the Trump-era rules.
Second, with a keen eye on the European Union Directive on Sustainable Finance (the EU’s so-called anti-greenwashing disclosure regime), the U.S. Securities and Exchange Commission has also weighed in on ESG matters.
In a risk alert issued by the SEC’s Office of Compliance, Inspections and Enforcement on April 9, the SEC laid bare “deficiencies and internal control weaknesses” gleaned from their regulatory inspections of investment funds from an ESG perspective. The document is one of the clearest and most important critiques of ESG investing practices to date.
The risk alert details clear observations that should strike fear into the hearts of investment managers and superannuation trustees alike, including:
- Portfolio management practices were found to be “inconsistent with disclosures” about the fund manager’s approach to ESG investing
- “Lack of adherence to global ESG frameworks where firms claimed such adherence” (while not mentioned explicitly, we can infer that the SEC has identified PRI signatories who are not following the PRI framework)
- Fund manager’s controls were discovered to be “inadequate to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions”
- Proxy voting was noted as being “inconsistent with advisers’ stated approaches”
- The SEC also found controls to be inadequate “to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices”; and “Unsubstantiated or otherwise potentially misleading claims” were made regarding ESG approaches
This highly concerning finding from the U.S. regulator goes straight to the core of greenwashing – some asset managers could not prove to the SEC that they actually did integrate ESG into their investment decisions in the same way their marketing materials said they did.
It’s worthy to note that during our ESG due diligence work on behalf of Australian investors, Castle Hall has found examples of every one of the findings reported by the Securities and Exchange Commission.
This risk alert is a clear statement that the SEC intends to focus on ESG going forward, with aggressive attempts to uncover greenwashing by managers who are active in the U.S.
Which raises a further question: how does this effect a super fund, especially one with clearly articulated ESG aims and objectives, that are implemented through external fund managers?
According to a legal opinion released in April by the Centre for Policy Development and penned by Noel Hutley SC and Sebastian Hartford Davis, the answer is clear: “greenwashing can constitute misleading or deceptive conduct, including for organisations selectively disclosing their exposures or not taking credible steps to operationalise net zero commitments”.
Moreover, the opinion also articulates a legal view that, as universal owners, “superannuation funds have a major interest in supporting an economically and socially sustainable zero carbon transition”.
With an increasingly activist member base it seems clear that super funds cannot rely on representations from third party managers without professional sceptical due diligence: the SEC’s experience provides clear evidence that fund managers have been subject to multiple of failings when it comes to ESG. Detailed, meaningful ESG reviews of fund managers enable super funds to satisfy their own ESG goals – is the super fund investing with a manager who can actually evidence proactive and effective integration of ESG factors in their investment process? In addition, a consistent, evidenced and auditable ESG due diligence workflow provides a defence to burgeoning litigation risk.
Looking forward, with the SEC now putting ESG risks firmly in its cross hairs, it can only be a matter of time until a well-known manager is exposed as a “greenwasher”. That means fines, industry bans and reputational damage for the fund manager and reputational spill exposure to that fund manager’s investors. If super funds have appointed such a manager, they will be under major scrutiny from their members and of course the press. Conducting a specialist ESG review of fund managers should therefore be an urgent priority.
