The European Union (EU) has recently implemented some investment regulations that require significantly more transparency in funds that invest in stocks with an environmental, social, or governance (ESG) bent. Could these same regulations be coming to the U.S. next—and if so, what do they mean for ESG investors?
What Regulations Were Recently Enacted?
EU regulators have long been concerned about the "greenwashing" of ESG stocks—or the overselling of any positive environmental and social impact they may have. Some funds are ESG in name only, making it tough for investors to know whether they're really having their desired impact.
Beginning in 2022, all asset managers that offer funds in the EU must classify their funds in one of three categories:
- Non-sustainable funds—with no particular ESG characteristics;
- Moderately sustainable—fit into certain social or environmental categories;
- Sustainable—actively contribute to a certain ESG objective or goal.
Because this Sustainable Finance Disclosure Regulation applies to all asset managers who do business in the EU—even those who don't live there—these regulations may very well bleed over into the U.S. markets. And the SEC, which has also turned its eye toward greenwashing over the last few years, has announced that it plans to give a closer, more critical review to ESG funds to ensure that they are complying with their posted objectives.
How Might These Changes Impact American ESG Investors?
These EU regulations have had a ripple effect across the globe. Already, Morningstar has announced that it plans to collect information on self-proclaimed green funds so that users can look up the European counterpart to a U.S.-based fund to gauge this fund's compliance with its objectives. These more detailed and forthcoming disclosures may significantly reshape the types of ESG funds that are offered. As brokerages and advisors compete for business, it may be a race to the top when it comes to providing comprehensive ESG information to clients and potential clients.
The U.S. Department of Labor has also recently announced that it will no longer enforce two ESG rules that were just finalized in 2020. These rules were designed to make it more difficult to include ESG funds in various employer-offered 401(k) plans, requiring fiduciaries to look only at "pecuniary factors" when choosing funds. This meant that funds that were intended to fulfill a certain social or environmental purpose could not be considered alongside non-ESG funds; the fiduciary was bound to look only at the fundamentals.
With this non-enforcement announcement and the EU's regulatory changes, it seems likely that ESG funds are about to stage a major comeback. As more fiduciaries begin offering these funds, competition among the funds themselves may well increase, which could give investors more ESG choices than ever before.
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