Fund Managers, Regulators Wrestle Over Plans to Tighten ESG Rules
Financial firms and data providers skeptical of proposed rules to clarify environmental, social and governance standards
Fund Managers, Regulators Wrestle Over Plans to Tighten ESG Rules
Financial firms and data providers skeptical of proposed rules to clarify environmental, social and governance standards
Diamondback Energy, one of the largest oil producers in the Permian Basin, received a ratings upgrade from leading ESG rater MSCI in May.
PHOTO: CALLAGHAN O’HARE/BLOOMBERGNEWS
Oct. 4, 2022 5:30 am ET
Regulators in the U.S. and Europe are trying to tighten rules on popular environmental, social and governance investment products, triggering a backlash from investors and businesses.
ESG funds have boomed in recent years, exceeding $350 billion in net assets in 2021 in the U.S., as investors look to fund companies that are addressing climate change and other issues. But murky disclosures and lax standards are driving regulators to tighten the rules.
Proposed regulations from the Securities and Exchange Commission would establish a common benchmark for how sustainable investment products are labeled, marketed and reported. That could lead to investors pulling cash from funds that don’t appear to be taking the standards seriously.
“In the short term, these rules, if adopted, may result in a decrease in total assets invested in funds that purport to be sustainable,” Mindy Lubber, chief executive of nonprofit sustainability advocacy group Ceres, wrote in a letter to the SEC. “We believe that ultimately, they would bolster confidence in climate and other ESG investment products.”
BlackRock Inc. and other investors are urging the SEC to change key provisions of a rule that would require investment advisers and companies to disclose how ESG factors influence investing decisions. In Europe, some ESG data providers rejected calls for regulatory intervention meant to monitor the transparency and comparability of environmental ratings.
ESG definitions vary widely between funds, making it possible for fund managers to exaggerate their consideration of environmental and other criteria in selecting constituents, according to the SEC. Mutual fund ratings firm Morningstar counted more than 600 funds mentioning ESG in investor literature before it changed how it tracked such funds in part because blanket sustainability statements are increasingly common, the company said in a letter to the SEC.
The proposed SEC rules seek to enforce consistency of ESG disclosures by requiring advisers of sustainable funds to describe which factors are considered and in some cases the portfolio’s carbon footprint, among other changes. A separate measure to update rules for fund names to ensure they accurately reflect their investments is also being considered.
BlackRock’s CEO is an outspoken proponent of climate-friendly policies and the company has made socially responsible funds the centerpiece of its $8.5 trillion business. The asset manager is seeking changes to parts of the SEC’s recent proposals to disclose more climate-related details.
The company said funds shouldn’t have to disclose proprietary ESG data points that BlackRock believes the proposed rules may require. It questioned why regulators raised environmental concerns above other social and governance considerations, according to an August letter.
Many large U.S. investment advisers are also subject to European rules, where regulators have some of the world’s most stringent environmental-disclosure policies and are considering tighter regulations. Among them is the creation of a single rulebook to cover ESG ratings that would force firms to publish more information about how they score companies.
Money is a sticking point in climate-change negotiations around the world. As economists warn that limiting global warming to 1.5 degrees Celsius will cost many more trillions than anticipated, WSJ looks at how the funds could be spent, and who would pay. Illustration: Preston Jessee/WSJ
Ratings from different providers rarely agree, leading to investor confusion, Europe’s financial regulatorsaid last year. A Wall Street Journal analysis of nearly 500 companies rated by three dominant ESG data providers found a fund’s performance depends largely on the rater used to evaluate stocks. Advisers use those scores to build their portfolios of sustainably branded funds. Their strategies rarely detail what metrics matter most and leave room for the inclusion of firms with significant carbon footprints, a Journal analysis showed.
Leading ESG rater MSCI disagreed that regulation was necessary and said attempts to standardize ESG scores between data providers would have a negative impact on the market and lower the quality of ESG ratings, Neil Acres, the firm’s global head of government and regulatory affairs, said in a letter to the European Commission.
The path taken by oil producer Diamondback Energy into sustainable funds demonstrates how current disclosure practices don’t typically capture how funds use ESG factors along with more-traditional factors such as valuation. The company, one of the largest oil producers in the Permian Basin, was considered an ESG laggard by MSCI since 2018 with one of the lowest scores in the oil-and-gas-exploration sector.
Last year, the company announced a goal to achieve net-zero direct emissions by both reducing the intensity of its carbon-dioxide emissions and by offsetting the rest. The company offset 1.2 million tons of 2021 greenhouse-gas emissions by purchasing the equivalent amount of carbon credits.
The credits were created by projects in 2005 that sequestered carbon dioxide to be used in drilling for oil. The credits don’t take into account emissions from the use of fuels pumped from wells. This May, MSCI upgraded Diamondback to average, noting its emissions-reduction target.
Buying by firms including BlackRock’s U.S. Carbon Transition Readiness ETF followed the upgrade. The fund uses a proprietary methodology with 150 data points from three firms to weight individual companies relative to a benchmark and sold off its stake in Diamondback last year.
Under European rules, the BlackRock ETF disclosed in September that it isn’t targeting sustainable investments. Diamondback Energy anticipates running its wells through 2050, according to the company’s sustainability report. The company declined to comment.
MSCI said Diamondback Energy’s ratings upgrade was driven by improved performance in occupational safety, toxic emissions and oil -spill intensity metrics. The key drivers in ratings changes are available to MSCI clients, the company said.
Write to Shane Shifflett at shane.shifflett@dowjones.com
Regulators in the U.S. and Europe are trying to tighten rules on environmental, social and governance investment products, triggering a backlash https://www.wsj.com/articles/fund-managers-regulators-wrestle-over-plans-to-tighten-esg-rules-11664845856?st=zrs48ktmvhlltof&reflink=article_imessage_share