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 proposed a pair of 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 proposals, which are subject to public input, outline how ESG funds should be marketed and how investment advisors should disclose their reasoning when labeling a fund.

See SEC proposals and .

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."

The new "Fund Names" proposal would seek to expand the number of funds that must invest 80% of their assets in line with their names and investment policies.

An SEC official said the agency estimates the rule would capture around 75% of all funds versus 62% currently, and would bar funds from using "ESG" labels if those factors are not central to investment decisions.

While the new rules will affect most funds, including index 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.

Andrew Behar, president of climate-activist group, As You Sow, said market participants have exploited a loophole in the current rules when naming funds.

Other advocates, including Washington-based advocacy groups Public Citizen and the Sierra Club said that the lack of marketplace transparency makes it hard for investors to untangle exactly how environmentally-friendly some of these products are.

"These SEC rules, once finalized and adopted, should finally give investors consistent and reliable information they can use in deciding which asset managers and funds truly align with their values and financial goals," said Ben Cushing of the Sierra Club.

On Wednesday, the agency also proposed a rule that would boost disclosures for ESG strategies in fund prospectuses, annual reports and advisor brochures.

SEC Chair Gary Gensler said in a statement that the measures respond to growing investor demand for such details.

"It is important that investors have consistent and comparable disclosures about asset managers' ESG strategies so they can understand what data underlies funds' claims and choose

the right investments for them."

Industry groups warned, 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.

The Managed Funds Association said it hopes the new rules recognize the diversity of investment strategies that enable institutional investors--including pensions, foundations, and endowments--to achieve their ESG goals.