Will Revisiting SEC’s Names Rule Clear Up ESG Fund Name Confusion?

The Securities and Exchange Commission recently asked for public comment on the issue of Fund Names (the “Names Rule”) and whether the Names Rule is still relevant or needs to be updated. You can see the comments of CFA Institute here.

The Commission proposed the Names Rule in February 1997 and adopted it in January 2001. In adopting the rule, the Commission cautioned against investors relying on a fund’s name as the sole source of information about the fund’s investments and risks but recognized that “the name of an investment company may communicate a great deal to an investor.” The final rule requires a fund to invest at least 80 percent of its assets in the manner suggested by its name, whereas previously funds considering then-current staff guidance typically would select fund names based on a 65 percent threshold.

The rule does not apply to fund names that describe a fund’s investment objective, strategy, or policies.

The rule has not been amended since its adoption in 2001, although since that time, staff and industry have identified a number of challenges regarding the application of the rule.

Much of the impetus behind revisiting the rule is the proliferation of environmental, social, and governance (ESG) or sustainable investment products entering the market. The SEC is concerned that the names of these products may mislead investors given the lack of a universal definition of what ESG or sustainable investing means, so the ESG and sustainable funds or exchange-traded funds in the market vary widely in their philosophy of what defines ESG or sustainable investing.

Firms use fund names to both market themselves and to inform investors. Fund names are always important, but in the case of the current challenges with funds that advertise themselves as ESG or sustainable funds, disclosures beyond the fund name would be especially helpful.

A definition of ESG/sustainability remains elusive and this likely will not change in the future because of the many methods relative to ESG integration. One of the main problems surrounding ESG and sustainable products is that individuals apply their own definitions of ESG or sustainable investing. If someone is looking for an ESG fund, and they read an ESG or sustainable title, they likely project their own expectation of what that fund offers.

Requiring funds to explain to investors what they mean by the use of these terms might be helpful. Because funds use these terms in different ways, investors who try to compare funds risk ending up even more confused. CFA Institute believes the best way to achieve transparency and comparability and to protect investors, is to require funds to explain to investors how the terms ESG and sustainability relate to the fund’s objectives, constraints, strategies, and characteristics of investments in a way that is both transparent and comparable.

Regulatory activity around ESG issues has been gaining momentum. The SEC’s own Investor Advisory Committee recently recommended that the SEC should update its reporting requirements for issuers to include ESG factors, and the Commission’s Investor Advisory Committee approved on May 21 a recommendation drafted by the committee’s investor-as-owner subcommittee on the subject.

CFA Institute is developing an industry standard for the classification and disclosure of ESG investment products. The purpose of the standard is to enable investment managers to better communicate the features and benefits of ESG investment products and to allow clients to better understand and compare ESG investment products with respect to objectives, constraints, methods (strategies), and holdings (assets), much like the CFA Institute Global Investment Performance Standards (GIPS®) enable transparency and comparability with respect to past performance.

CFA Institute selected 15 volunteers, from more than 200 applicants, to serve on a working group whose purpose is to propose the structural elements of the standard and to seek public comment on the proposal. The members of the working group come from seven different countries; have deep ESG expertise; and bring experience as asset owners, investment managers, consultants, service providers, and standard setters. The working group aims to have a proposal out for consultation near the end of July 2020 and final recommendations by the end of the year. The group expects an exposure draft of the standard to be released in the summer of 2021 and the final standard to be released in 2022.

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