Regulatory Examination Priorities & ESG Programs

Regulatory Examination Priorities & ESG Programs

Investment strategies focusing on certain environmental or social themes have been around for a long time. Historically, these strategies were highly specialized, perhaps prohibiting tobacco, weapons or were investing along faith-based principles. Over the past few years, as society has become more aware and vocal with respect to environmental, social and governance (ESG) issues, investors have increasingly looked for options that better align to their views. As such, we have seen an explosion of investment strategies and products claiming to invest along these themes. In fact, Bloomberg estimates that global ESG assets could reach $53 trillion by 2025[1], representing about a third of all investments.

And as the money goes, so go the regulators. … If you were a contestant on Wheel of Fortune and the topic was “Things Regulators Are Focused On”, we’d recommend choosing the letters E, S, G.  

In March of this year, the U.S. Securities and Exchange Commission (SEC)  announced the creation of the Climate and ESG Task Force, part of Division of Enforcement, with a dedicated focus on developing initiatives to proactively identify ESG-related misconduct. The task force will use advanced data analysis to mine and assess information across registrants- in particular, disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.

In April, we were treated to the Division of Examinations’ Review of ESG Risk Alert. This Risk Alert highlights observations from recent examinations of firms that offer ESG products and services and also offers insight into how ESG practices are being evaluated during exams. The Risk Alert promised that upcoming examinations will continue to include an ESG focus, especially pertaining to:

  • Portfolio management practices
  • Proxy voting
  • ESG disclosures including regulatory filings, websites, reports to sponsors of global ESG frameworks, client presentations, responses to DDQs & RFPs, and other marketing materials, and
  • Compliance with firms’ own stated policies and procedures and the effectiveness of their implementation

If this hasn’t gotten your attention yet, on June 11, 2021 the SEC released its Annual Regulatory Agenda, which also reflects the heightened focus on ESG issues. The agenda advises we should expect rulemaking later this year focused on human capital and workforce diversity disclosures in addition to climate change disclosures. The Commission is also considering proposing requirements relating ESG claims and related disclosures made by advisers and investment companies.

This regulatory focus is not by any means unique to the USA. In the European Union, components of the Sustainable Finance Disclosure Regulation (SFDR) became effective in March. The SFDR is designed to make it easier for investors to distinguish and compare between the many sustainable investing strategies that are now available.  It focuses on increasing transparency on the degree to which financial products have ESG characteristics, invest in sustainable investments or have sustainable objectives. It’s further intended to help direct capital toward sustainable activities and prevent greenwashing. To accomplish this, investment firms, asset managers and other market participants are now subject to expanded disclosure and reporting requirements.

Back in the US, the SEC has said that they expect to bring their first enforcement cases later this year. Early cases in new areas of examination generally are pretty clear-cut and we expect the first cases in ESG enforcement to represent the “low hanging fruit.” When it comes to developing an ESG action plan, some action steps a CCO can take:

  • Educate yourself. A CCO needs to have some knowledge on the topic and be conversant on ESG issues. Do not think of ESG as another investment strategy that lives in the black box of portfolio management.
  • Look at governance. With respect to ESG strategies, ensure that there a robust dialog that involves portfolio management, sales, marketing and compliance. Consider whether there should be a formal committee, given the size of the organization, how remote the workforce is and the flow of information.
  • Evaluate the process. Ensure that the ESG inputs are captured and documented. If your firm is using third-party data, document how that data is used in the decision-making process and what role any internal research plays. Often an adviser will use third-party data and apply their own consideration of various factors.
  • See what you say. Review marketing materials and disclosures for consistency and to ensure they reflect what is actually happening. This review must include any filings made with ESG standards bodies, like the UN PRI. A firm needs to walk the talk.
  • Review. A firm needs to conduct a robust review of their ESG policies and procedures. Consider engaging a third party to conduct an independent mock exam that tests the controls around the investment process, operations and client communications.

Clearly climate and social issues are part of the global conversation right now and investor dollars are reflecting the importance of these issues. Regulators want to ensure that the new products are living up to their claims, so we expect this to be a hot button for a while.

For more information or to speak with a regulatory expert, please email