Private markets may not swerve the SEC’s sustainability agenda for long

Private markets could be next on the agenda for the Securities and Exchange Commission as the US regulator works to standardise ESG investments.

On Monday, the SEC targeted publicly traded companies with the release of a long-awaited rules proposal that could force the mandatory reporting of climate-related risks including Scope 1, 2 and 3 greenhouse gas emissions. The proposal has entered a 60-day period for public comment before final approval, but the regulatory agency has other ESG items on its agenda that could shift focus to private markets investors.

Front and centre, the SEC’s outstanding governing plan could include a proposal to introduce “requirements for investment companies and investment advisers related to environmental, social and governance factors, including ESG claims and related disclosures”, according to the commission’s Regulatory Flexibility Agenda. The proposal is under consideration by the agency’s Division of Investment Management, which has earmarked the release of a draft for some time in April. (The SEC’s timeline for rule proposals can be delayed, as seen with the climate disclosures proposal which was scheduled for release in December.)

Based on what the SEC has made public since last April, when Gary Gensler took over as the commission’s chair, the proposal seems likely to focus on the categorisation and marketing of ESG funds. Gensler has signalled that cracking down on the misrepresentation of sustainable investment strategies, or greenwashing, will be a top regulatory priority early in his tenure.

Shortly before Gensler’s arrival in April, the SEC issued a “review of ESG investing” risk alert outlining the agency’s “observations of deficiencies and internal control weaknesses” after examining how investment funds and advisers promoted and implemented sustainability strategies.

The alert served as a warning to asset managers after describing “inconsistent” portfolio management practices, “inadequate” sustainability guidelines and “unsubstantiated or otherwise potentially misleading claims regarding ESG approaches”.

Cybersecurity in private markets is one theme that’s already seen a draft proposal approved and opened for public review. In February, the SEC released draft rules that would strengthen requirements for avoiding cybersecurity risks that “could harm advisory clients and fund investors”, as well as enforce disclosures of “significant” cybersecurity incidents.

The SEC has formed a long list of possible reform actions, but no item is certain to receive the regulator’s full approval, not to mention the standing to survive legal challenges. The agency is also considering proposals related to human capital management and corporate board diversity. While these proposals seem focused on publicly traded companies, they also would likely affect how private markets investors grow and manage their portfolios.

All this potential regulatory movement in the US is occurring as global asset managers face the reality of complying with the EU’s ESG standards. In July, the EU plans to release a second round of rules governing its Sustainable Finance Disclosure Regulation framework, which was enacted last March to increase ESG reporting requirements for public and private fund managers. The new regulations are already forcing asset managers based overseas to comply with the EU’s ESG standards or lose out on available pools of private capital.