The seal of the U.S. Securities and Exchange Commission (SEC) is seen at their headquarters in Washington, D.C., U.S., May 12, 2021.
The seal of the U.S. Securities and Exchange Commission (SEC) is seen at their headquarters in Washington, D.C., U.S., May 12, 2021. Reuters / Andrew Kelly

The U.S. Securities and Exchange Commission (SEC) on Wednesday will propose rule changes aimed at stamping out unfounded claims by funds on their environmental, social and corporate governance (ESG) credentials, and enforcing more standardization of such disclosures.

The proposal will outline how ESG funds should be marketed and how investment advisors should disclose their reasoning when labeling a fund, according to people who have spoken to the SEC on the measures.

The proposal would also mandate that investment funds with terms such as "ESG," "sustainable" and "low-carbon" in their names disclose the criteria and underlying data used to support the label, the people said.

While the new rules will affect all funds, their target is ESG funds which drew a record $649 billion globally through Nov. 30, up from $542 billion and $285 billion in 2020 and 2019, respectively, according to Refinitiv Lipper data.

Regulators and activists have become concerned that U.S. funds looking to cash in on the popularity of ESG investing may be misleading shareholders over their products' underlying holdings, a practice known as "greenwashing."

"We are hopeful that the new rule will require fund managers to follow basic naming guidelines. This will help to eliminate confusion and misleading marketing," said Andrew Behar, president of climate activist group As You Sow, who has discussed the potential rules with the SEC.

He said market participants have to date exploited a loophole in the current rules when naming funds.

SEC Chair Gary Gensler has said that when it comes to sustainability-related investing, asset managers might confuse investors with conflicting names or certain terms or criteria they use.

Industry groups warn, however, that the agency's aim to standardize ESG labels could reduce investor choice.

"We object to actions that would ... substitute a regulator's judgment about investment strategy for that of professional fiduciaries," said Janay Rickwalder, a spokeswoman for the Investment Adviser Association, adding that her group has discussed the matter with the SEC on these themes.