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US SEC exam letter focuses on ESG

You can compare the new exam request letter with one RCW shared two years ago to see DOE’s evolution regarding ESG. If your firm engages in ESG investing, or plans to, you’d be wise to eye what examiners are asking about.

You had to know that US Securities and Exchange examiners would show renewed interest in the hottest investing topic circling the globe: ESG.

Affiliate title Regulatory Compliance Watch has obtained a Division of Examinations exam letter (susbcription or registration required) that delves deeply into environmental, social and governance and socially responsible investing issues. The timing of the letter isn’t clear, so we don’t know if advisors received it before or after the DOE’s recent ESG risk alert.

You can compare the new exam request letter with one RCW shared two years ago to see DOE’s evolution regarding ESG. If your firm engages in ESG investing, or plans to, you’d be wise to eye what examiners are asking about.

Defining your terms

The new letter begins by asking the advisor to define “impact investing” and “any terms” it uses in disclosures and marketing, as well as to describe its “ESG/SRI criteria”. The advisor is asked to give examiners its ESG P&Ps, including “previous versions” to compare the firm’s progression regarding impact investing.

If the advisor “adheres to any ESG/SRI industry standard(s)”, it was asked to “provide written documentation” of how it uses these standards.

Should the advisor turn instead to “a proprietary scoring system” for ESG, it needed to hand over its methodology and to reveal “how often the score is evaluated”, its related written processes and how often investors see the scores.

Examiners also asked if the advisor used “a third-party scoring system” for its ESG criteria. The advisor had to disclose why it selected that particular system, how it uses the scores and “how often the score is evaluated”.

If the advisor deploys model investment strategies, it had to “describe each investment strategy and explain whether, and if so how, such Registrant selects the investments and monitors and assesses performance relating to ESG/SRI criteria or matters”.

Examiners also sought the firm’s trade blotter in an Excel format but with a new column added to show “whether the transaction has an associated ESG/SRI score”, according to the new letter. They also wanted copies of contracts with sub-advisors and “three examples” of correspondence with service providers related to ESG.

As with typical exam letters, the SEC requested a long list of items related to account trades but this new letter added a couple of new items to that inquiry:

  1. “A description of (or records identifying) the ESG/SRI criteria that formed the basis for the recommendation; and
  2. If a Registrant uses a scoring system as part of its ESG/SRI criteria, include the corresponding scores for the investment.”

A change of heart

If the advisor had cooled on an ESG investment, it was asked to explain why and to cite some examples. At the very least, the advisor was asked to describe “why the five largest [ESG-based] previously held positions (dollars invested across all clients) are no longer recommended”.

Similarly, the advisor was asked to reveal its “three most profitable and three least profitable” ESG investments during the exam period.

Compliance assessments

On the compliance side, the firm needed to provide examiners with copies of “any periodic compliance or internal audit evaluations that assessed the adequacy of the design or implementation of the above-mentioned compliance and operating policies and procedures (regulatory compliance or use of ESG/SRI criteria)”.

All “pitch books”, brochures, newsletters and other materials touching on ESG were also requested. Private fund advisors were asked to share “fund organisational documents”, including any “provisions about ESG/SRI matters or criteria”.