ESG (Environmental, Social and Governance) products and financial services have become a popular word in the world of regulation. With the SEC’s Risk Alert on The Division of Examinations’ Review of ESG Investing and the most recent 2022 SEC Examination Priorities Report, understanding key compliance considerations to protect your Firm is vital. If your Firm provides these products and financial services, we have provided some key tips and compliance considerations.

What is ESG Investing:

ESG investing is a term that has many different meanings and may go by different names such as sustainable investing, socially responsible investing, and impact investing. The actual underlying strategies behind the investment vary from selecting companies based on their stated commitment to one or more ESG factors. For example, companies with policies aimed at minimizing their negative impact on the environment or companies that focus on governance principles and transparency. Managers may also focus on up-and-coming companies that are improving with ESG related initiatives. On the other side, it can also be excluding companies that don’t adhere to these principles.

Examination Challenges:

The SEC noted during a number of examinations of Firm’s who provide ESG related products and services common themes and challenges that include the following:

  • Portfolio management practices were inconsistent with disclosures about ESG approaches
  • Controls were inadequate to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions
  • Proxy voting may have been inconsistent with advisers’ stated approaches
  • Unsubstantiated or otherwise potentially misleading claims regarding ESG approaches
  • Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices
  • Compliance programs did not adequately address relevant ESG issues
  • Inadequate knowledge and oversight by compliance personnel

Compliance Best Practices:

The SEC noted firms with programs that were great examples of effective risk based ESG programs. A summary of the key areas are below.

  • Disclosures that were clear, precise and tailored to firms’ specific approaches to ESG investing, and which aligned with the firms’ actual practices. This includes simple and clear disclosures on the Firm’s approach to investing, ESG considerations with other factors in the disclosure that don’t take away from the ESG framework requirements, and explanations regarding how investments were evaluated using goals established under global ESG frameworks.
  • Policies and procedures that addressed ESG investing and covered key aspects of the firms’ relevant practices. This included documentation of specific phases of the ESG product journey (i.e., research, due diligence etc.), detailed and comprehensive investment policies and where multiple ESG investing approaches were employed at the same time, specific written procedures, due diligence documentation, and separate specialized personnel provided additional rigor to the portfolio management process.
  • Compliance personnel that are knowledgeable about the firms’ specific ESG-related practices. When compliance personnel were integrated into the actual ESG process and those personnel were trained and knowledgeable about the products and risk considerations, there were better written policies, less issues with misleading marketing claims and more rigorous review processes.

MasterCompliance provides expert consulting in compliance best practices and support in creating a risk based program. If you would like to explore additional assistance or services, please contact us.