In February 2023, CFA Institute released third-party assurance standards for firms claiming compliance with its Global ESG Disclosure Standards for Investment Products (the “Standards”). As controversy over the proposed SEC ESG Rule grows, it’s important to understand the CFA Institute’s voluntary framework and assess the benefits of voluntary compliance and assurance on a firm’s investment products, as well as the similarities and differences in proposed regulations.
An Overview of the CFA Institute’s Global ESG Disclosure Standards
The CFA Institute’s Standards are designed to provide investors consistent, reliable ESG information that is complete and clear, to increase investor trust in the industry and avoid misleading greenwashing. The Standards allow firms to have specific ESG investment products claim compliance with these Standards and, as of February 2023, firms can have an independent third-party provide assurance for this claim. Unlike the proposed SEC ESG Rule, the Standards do not include any corporate or firm-level disclosures (other than stewardship activities discussed below). The Standards include consideration of the intersection of a firm’s ESG policies, on a product-by-product basis, and that investment product’s objectives, investment strategy, and stewardship activities. Firms that claim compliance with the Standards must document internal ESG policies and procedures that support the firm’s ESG-related marketing statements. Third-party assurance then adds an extra layer of accountability to further increase investor’s confidence that these products are actively and intentionally carrying out their ESG initiatives.
Sources and Types of ESG Information and Associated Disclosures
The ESG Disclosure Standards have different required disclosures for the various sources and types of ESG information. Below is a list of the sources and types of ESG information and a summary of the ESG Disclosure Statement requirements associated with each source/type.
- Financially Material ESG Information: Disclosures will need to describe how financially material ESG information is identified and incorporated into investment decisions, and any exceptions in which financially material ESG information is not considered in investment decisions.
- ESG Investment Universe (ESG index): if an ESG index is used as part of a product’s investment selection process, the disclosures will need to include either a description of how investors can obtain information about the index’s construction methodology, or, if the index is readily recognized, just the name of the index.
- Screening: If the investment product excludes certain investments or has criteria that must be met before an investment is considered, required disclosures include the characteristics and thresholds/conditions used to evaluate the investment, where the criteria are applied in the investment process, and whether there are any laws, regulations, or third-party frameworks used in the evaluation criteria.
- Portfolio-Level ESG Characteristics: products with portfolio-level targets for ESG characteristics will need to disclose:
- the portfolio-level ESG characteristics, how they are measured, the target value or range, how the target is expected to be attained, any risks that could hinder an attainment of the target, and whether there are any laws, regulations, or third-party frameworks used to measure the characteristics or targets.
- If the product’s targets are compared to an ESG index, additional disclosures include the characteristic that is compared to the index, information about the index (depending on recognizability, similar to ESG Investment Universe requirements), and how investors can obtain information about the index calculation methodologies.
- How progress toward, or attainment of, the targets are reported to investors.
- Portfolio-Level Allocation Targets: products with portfolio-level allocation targets must disclose the specific ESG characteristics that are targeted, the value or range of the target, and how progress toward, or attainment of, those targets is reported to investors.
- Stewardship Activities: disclosures must include the types of Stewardship Activities undertaken by the product, how the Stewardship Activities are relevant to the product’s objectives, and the processes/systems that support the Stewardship Activities. Additionally, disclosures must be made on how investors can obtain all policies which govern the products’ Stewardship Activities and how the Stewardship Activities are reported to investors.
- Environmental and Social Impact Objectives: disclosures must include the impact objectives (in measurable or observable terms), stakeholders who will benefit from these objectives, the time horizon over which the objectives are expected to be attained, how these objectives relate to other objectives of the product, and how the pursuit of impact objectives could result in a trade-off with other objectives. Other required disclosures include:
- The proportion of the portfolio focused on these impact objectives
- How they’re expected to be attained
- Any risks that may hinder attainment of these objectives
- How progress toward, or attainment of, the impact objectives is measured/monitored/evaluated
- How progress is reported to investors
- The process for assessing/addressing/monitoring/managing potential negative social and environmental impacts that may occur while attaining these objectives
- How the attainment of impact objectives will contribute to third-party sustainable development goals.
The Standards vs. the Proposed SEC ESG Rule
- The Standards are voluntary guidelines for asset managers and asset owners, while the proposed SEC ESG Rules would be mandatory for public companies that are subject to SEC reporting requirements.
- The Standards include a new investment product-specific disclosure document—the ESG Disclosure Statement, while the proposed SEC ESG Rule disclosures would be added to already-existing documents such as fund prospectuses, annual reports, and regulatory reporting (Form ADV Parts 1 and 2), and the disclosure requirements vary based on the document in question.
- The proposed SEC ESG Rule includes a significant emphasis on corporate Greenhouse Gas Emission (GHG) disclosures and a prescribed methodology for the calculation and presentation of GHG computations, while the Standards provide a framework that would include such considerations, if included in an investment product’s ESG approach, without addressing them specifically.
- In contrast to the type of ESG investment-specific disclosures required by the Standards, the proposed SEC ESG Rule’s general requirements are broken down into two types of funds:
- Integration Funds: ESG factors are incorporated alongside non-ESG factors in the investment process, but the ESG factors are no more significant than the other factors.
- ESG-Focused Funds: Funds which focus on one or more ESG factors as a significant or main consideration in investment decisions (includes Impact Funds).
The required disclosures for Integration Funds are not as comprehensive as the required disclosures for Focused Funds (detailed in the graph below), and include ESG factors considered, a few sentence summary of how the Fund incorporates such ESG factors in the investment selection process, and a description of GHG selection process and calculation methodology, if any.
- The Standards provide a set of recommended metrics and data points for reporting on ESG issues, while the SEC’s Proposed Rules do not prescribe specific metrics beyond GHG calculations, but instead require companies to disclose material climate-related risks and opportunities.
- The Standards are a finalized, flexible global framework, while the proposed SEC ESG Rule is still a moving work-in-progress limited to U.S. companies.
The Standards and the proposed SEC ESG Rule both prioritize the disclosure of material ESG information that is relevant to a company’s business and financial performance. They also are designed to be compatible with existing reporting frameworks, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB)
Below is the tabular format in which the SEC has proposed ESG-Focused Funds present the required information in their Fund Prospectuses. We’ve added an additional column to show the comparison between the proposed SEC ESG Focused Fund disclosures and the Standards.
In summary, the Standards and the proposed SEC ESG Rule have different scopes, focus areas, and approaches to ESG reporting. However, both initiatives are aimed at improving transparency and accountability in ESG reporting, which can help investors make better-informed decisions and promote more sustainable business practices.
As firms consider if they will comply with the CFA Institute’s voluntary Standards, we are here to help. If your firm is interested, please contact us to discuss Cascade Compliance’s ESG consulting and assurance solutions.
Cascade Compliance has over 34 years of combined experience working with SEC Regulations, the GIPS standards, and performance. Our employees have worked with hundreds of firms in the U.S. and abroad. One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry. Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have. Contact us at email@example.com.