New Regs Could Make ETF 'Greenwashing' a Little More Transparent

One of the struggles with covering funds focused on environmental, social and governance best practices is making apple-to-apple comparisons between exchange-traded funds. New regulation from the Securities and Exchange Commission, however, could now make it a bit easier to analyze the environmental aspects of ESG funds -- even if indirectly. Let me explain. In the past, when I've looked at ESG funds, I ended up comparing the ETF in question -- typically from an independent or emerging issuer -- to a fund from one of the Big 3 issuers, usually iShares or SSGA. When doing so, almost every time I ended up praising the targeted focus of the smaller issuer's product and pointing out that the industry titan product is far too homogenized. In many cases, I've found that the large issuer product is mostly indistinguishable from the same strategy in its non-ESG form. A myriad reasons can be found for this, but the biggest issue with developing ESG-focused investment products is that there is currently no set definition in the United States of what constitutes an ESG-friendly activity for publicly listed companies. We all understand, of course, that certain activities are harmful to the environment, violate certain social or labor norms, or run counter to above-board governance practices. But no consensus exists as to how much of an activity a company can be involved in and still be identified as being ESG friendly. Helpful Regulation? The SEC announced in February of last year that it would update its guidance from 2010 about what kinds of disclosures companies should consider regarding climate change. A SEC commission opened the conversation, inviting the public to comment on the proposed updates. On July 7 of last year, the Asset Management Advisory Committee issued its Recommendations for ESG in which it raised a number of points for the SEC to consider when drafting rules around ESG disclosure. Fast forward to March of this year, when the SEC published a proposed rule for public comment until May 20. For such disclosures, the SEC has three scopes of focus. Scope 1 covers direct greenhouse gas (GHG) emissions from assets owned by the company; Scope 2 covers GHG emissions from the electric power sources used by the company (manufacturing or other); and Scope 3 covers GHG emissions resulting from any activity not covered by Scopes 1 and 2. This, per the filing, covers emissions generated by sources not owned or controlled by the company and can include emissions generated through the production and transportation of manufacturing inputs from third parties, employee commuting or business travel, or even emissions generated from customers processing or using a company's product. These rules would apply to operating companies and not investment products. But, given a framework, fund developers and issuers will run with the rules to create a whole new set of ESG-screened products. These rules are set to come into effect through the next few years, starting with reporting for the fiscal year 2023 for some companies and expectations that the latest some companies would report would be in 2026 with 2025 fiscal data. Smaller reporting companies (SRCs) are exempt from reporting Scope 3 emissions. Impact on ETFs I'm glad to see some requirements and standardization around GHG emissions reporting as this new ruleset will allow investors to finally make apple-to-apple comparisons across companies and industries. What this doesn't do is set any standards for developers of investment products. Because of this, it is still going to be very difficult for new issuers to bring truly targeted ESG products to market. A clear example of the kinds of headwinds new issuers face is the case of iClima, which launched the iClima Distributed Smart Energy ETF about a year ago, which focuses on companies that are leading the way in distributed renewable energy. The fund is passive, tracking the iClima Distributed Renewable Energy Index. Reading through the index methodology shows iClima has put a good deal of thought into both the overall strategy and the nitty gritty of the security selection process. In about one year, the fund has managed to attract just over $2 million in assets under management. Compare this fund to the iShares ESG Aware MSCI USA ETF and you will find that while the index provider has ESG ratings for almost all of its holdings, there's very little it does to actively screen names out of the portfolio. ESGU has about $23 billion under management. You might say, well of course the Blackrock/iShares fund is huge, it was launched in 2016 and duh -- iShares... but that's the issue I have. ESGU is ESG in name only, as far as I can tell, and it and other greenwashed funds are stifling innovation and growth in the ESG-focused ETF space. Regular readers will have clued in by now that I am a supporter of new and innovative ETFs and the often new and innovative issuers that bring them to market. As I said earlier, I'm glad to see these reporting rules come into effect, but I'm not entirely optimistic that they will create any more clarity for ETF investors looking for effective ESG exposure. Still, if investors are open to exploring funds like SHFT, Harbor Corporate Culture Leaders ETF , Amberwave Invest USA JSG Fund , Freedom 100 Emerging Markets ETF , or issuers like Impact Shares they should be able to find solutions that truly do well and Good.

New Regs Could Make ETF 'Greenwashing' a Little More Transparent

Updates to SEC guidance could make it easier to compare the environmental part of ESG funds.

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