The demand for sustainable investment products and securities that incorporate good environmental, social, and governance (ESG) indicators has increased significantly around the world. In response, investment managers and advisors began to offer various investment options labeled sustainable, supposedly incorporating ESG factors. However, the lack of standardized and precise definitions in relation to ESG topics carries risks. When investment managers and advisors do not formulate clearly and consistently how they define ESG and how they use related terms (especially in retail products or services), they can confuse investors.
In this context, the Division of Examinations of the Securities and Exchange Commission of the United States of America (SEC) issued a risk alert, citing concerns regarding deficiencies, transparency failures, and weaknesses in the internal controls of investment managers and advisers for ESG products. At the same time, the agency recognizes and praises some effective practices that must be disseminated in the industry.
In its evaluation work, the SEC's Division of Examination took into account: (i) portfolio management, including review of policies and procedures, use of ESG terminology, due diligence and monitoring of investments in ESG topics; (ii) advertising and marketing activities, including review of the company's regulatory files, websites, external certification reports, customer presentations, and marketing materials; and (iii) compliance, including review of policies and procedures, compliance supervision, and review of ESG investment practices.
Among the points of concern and alert, the Division of Examination highlighted situations in which:
- unfounded or potentially misleading statements were used regarding ESG investment processes and adhering to global ESG classification standards;
- portfolio management practices were inconsistent with disclosures regarding ESG approaches;
- controls were inadequate to maintain, monitor, and update clients' ESG-related investment guidelines, mandates, and restrictions;
- the vote in the governance bodies of the investee companies was inconsistent with the declared approaches and public statements by managers related to ESG;
- there were inadequate internal controls to ensure that ESG-related disclosures and marketing were consistent with company practices; and
- compliance programs did not adequately address relevant ESG issues, especially when compliance department professionals had limited knowledge of ESG topics and performance metrics.
Among the ESG best practices observed with investment managers and consultants, the Division of Examination identified concrete cases of policies, procedures, and practices that seemed to be reasonably designed in view of their specific approaches to investment in ESG, highlighting the following:
- clear, accurate disclosures tailored to company-specific approaches to ESG investment and which have aligned with real business practices;
- ESG factors that could be considered together with many other factors and contrasted with international ESG standards adopted by evaluating bodies;
- explanations of how investments were evaluated based on targets set by international ESG standards;
- policies and procedures that addressed investment in ESG, while dealing with important aspects of the companies' business strategy and operational practices; and
- professionals from compliance-specific practices related to ESG of companies.
While the SEC's Division of Examination risk alert applies only to U.S. issuers supervised by such entity, Brazilian issuers, managers, and advisors can proactively evaluate the concerns and recommendations raised to mature their measurement, due diligence, internal controls, and disclosure practices related to their ESG products.