SEC to Propose More Disclosure Requirements for ESG Funds

Hester Peirce,

the lone Republican on the four-person commission, voted against both proposals, saying they would impose undue burdens on asset managers and nudge them toward capital-allocation decisions that only some investors favor.

The boom in what advocates call green or sustainable investing has posed a growing challenge to regulators in recent years. Assets in funds that claim to focus on sustainability or ESG factors reached $2.78 trillion in the first quarter, up from less than $1 trillion two years earlier, according to

Morningstar.

Though fees charged by such funds are typically much higher than what investors pay for low-cost index funds, there are few consistent standards for what constitutes an ESG stock, bond or strategy.

“What we’re trying to address is truth in advertising,” SEC Chairman

Gary Gensler

told reporters in a virtual press conference after the commission’s vote.

Some ESG fund managers only buy stocks of companies they believe to already have a small carbon footprint, while others might invest in firms that have publicly committed to doing better. Another strategy involves building a stake in a chronic polluter in hopes of winning seats on its board or forcing proxy votes that pressure the firm to change its ways.

The ambiguity has led to widespread concern among investors and regulators that the banks and asset managers who sell funds are “greenwashing,” or exaggerating their environmental or social sustainability to bolster their own revenues.

Earlier this week, the SEC fined the investment-management arm of

Bank of New York Mellon Corp.

$1.5 million for misleading claims about the criteria it used to pick ESG stocks. BNY Mellon neither admitted nor denied wrongdoing.

Authorities are also probing

Deutsche Bank AG’s

asset-management arm after The Wall Street Journal reported last year that DWS Group overstated its sustainable-investing efforts. At the time, a DWS spokesman said the firm doesn’t comment on questions related to litigation or regulatory matters. A spokesman for Deutsche Bank declined to comment.

The first proposal on the SEC’s docket Wednesday would overhaul requirements around fund names.

Under a rule passed two decades ago, if a fund’s name suggests a focus on certain industries, geographies or investment types, it must invest at least 80% of its holdings in such assets.

Wednesday’s proposal would expand the scope of the so-called Names Rule to cover funds that suggest a focus on ESG factors, or on strategies such as “growth” or “value.” A fund that merely considers ESG factors alongside—but not more than—other inputs wouldn’t be permitted to use ESG or related terms in its name.

“A fund’s name is often one of the most important pieces of information that investors use in selecting a fund,” Mr. Gensler said.

The second proposal being considered would require funds that consider ESG in their investment processes to disclose more information. So-called impact funds that seek to achieve an ESG-related objective would have to disclose how they measure progress toward that goal. Funds for which ESG investing is a significant or primary consideration would be required to fill out a standardized table as well as additional information about the greenhouse-gas emissions produced by the companies or issuers in their portfolios.

Mr. Gensler often likens such information to the nutrition facts printed on the back of a carton of skim milk.

“When it comes to ESG investing, though, there’s currently a huge range of what asset managers might disclose or mean by their claims,” he said Wednesday, adding that it can be difficult for investors to understand or compare funds. “People are making investment decisions based upon these disclosures, so it’s important that they be presented in a meaningful way to investors.”

Commissioners voted 3-1 to open the two proposals to public comment.

Ms. Peirce, the Republican commissioner, said the updates to the Names Rule risks changing the way some funds are managed as firms seek to avoid being captured by proposed criteria she characterized as subjective. The new disclosure requirements, Ms. Peirce said, would intensify pressure on funds to vote shares or compose their portfolios in accordance with activist investors’ wishes.

“If demand for greenhouse-gas disclosures is becoming the norm, let the standards and expectations develop organically,” Ms. Peirce said. “Let investors shape industry practice through their investing decisions, not through regulatory mandates about what investors ought to be considering.”

The American Securities Association, a lobbying group that represents regional brokerages and financial-services firms, applauded the SEC’s proposals, saying it’s appropriate to scrutinize ESG funds’ advertising, performance and fees.

“ASA supports efforts by the SEC to stop misleading and deceptive marketing gimmicks surrounding ESG funds,” the group’s chief executive,

Chris Iacovella,

said in an emailed statement.

The Investment Company Institute, which lobbies on behalf of the funds industry, didn’t respond to a request for comment.

—Amrith Ramkumar contributed to this article.

Write to Paul Kiernan at paul.kiernan@wsj.com