iStock.com / VectorMine

The ESG integration category is being criticized as “meaningless” and open to manipulation in response to the U.S. Securities and Exchange Commission’s ESG disclosure proposals.

The regulator proposed reforms earlier this year that would require funds to disclose more information to investors about their ESG strategies in an attempt to combat greenwashing. The proposals went out at the end of May for a 60-day comment period.

In comment letters submitted to the commission, the largest fund rating company and a leading shareholder advocacy non-profit were critical of the ESG integration category.

Chicago-based Morningstar Inc. called the category label “misleading” and said it could “contribute to greenwashing by making funds appear more committed to ESG factors than they are.” Berkeley, Calif.-based As You Sow said fund companies could take advantage of the integration category’s limited requirements.

Both organizations broadly supported the SEC’s goal to standardize and enhance ESG reporting.

The SEC proposals would categorize ESG strategies broadly and require funds to provide more specific disclosures in prospectuses, annual reports and brochures. The level of detail required in the disclosure would depend on the category of fund. ESG integration funds would provide more limited disclosures than ESG focused funds and impact funds.

According to the SEC’s proposals, ESG integration strategies consider ESG factors alongside other, non-ESG factors in investment decisions. “In such strategies, ESG factors may be considered in the investment selection process but are generally not dispositive compared to other factors when selecting or excluding a particular investment,” it said.

In its comment letter, Morningstar said funds should be subject to minimum standards and report data in the same format. The ESG integration category should be eliminated, it said, as it would include “too many funds using too little information to be meaningful.”

“Disclosing that a fund considers ESG is not informative for investors,” it said.

As You Sow said dividing funds into three categories could make it difficult for fund managers to determine which compliance regime applies. This in turn would compliance costs.

Instead, the SEC should require all funds that consider ESG factors to disclose the same information to investors, As You Sow said in its comment letter. This would allow investors to compare funds across ESG approaches.

“[E]liminating the proposal’s fund categories would simplify compliance, avoid investor confusion stemming from unequal disclosure across fund categories, and eliminate the incentive for funds to place themselves in the Integration Fund category to take advantage of its minimal disclosure obligations,” the letter said.