IQ-EQ outlines the ESG programs that will stand up under SEC exam scrutiny

While the U.S. lags behind Europe and other parts of the world when it comes to ESG, there has been heightened market interest recently, prompting the SEC to take a close look at ESG issues, including conducting targeted examinations.

Earlier this year, the SEC issued an ESG investing risk alert outlining top deficiencies found during exams.

Deficiencies found by exam staff include portfolio management practices inconsistent with disclosures about ESG approach; inadequate controls to monitor and maintain client ESG directives; unsubstantiated or otherwise potentially misleading claims regarding ESG approach; ineffective compliance practices to guard against inaccurate ESG-related disclosures and marketing materials; and a lack of appropriately tailored compliance policies and procedures related to ESG investing for firms substantially engaged in ESG investing.

Discussing the lack of consistency between ESG disclosures and actual firm practices, Libby Toudouze, a director at IQ-EQ, said she has seen firms that have a policy in place, but the policy does not translate consistently in their legal documents, their website, and their monitoring and reporting.

“Firms that have an ESG policy may not be applying consistently, or in a way to monitor and report on it. We try to help firms think about how to do that in the most efficient way,” she said.

Earlier this year, IQ-EQ launched IQ-EQ Compass, a service ESG compliance and helps firms build sustainable value and reputational resilience.

Compliance should play a key role in a firm’s ESG program, particularly reviewing the accuracy of disclosures. ESG-related issues should be fully integrated into a firm’s overall compliance program considering the potential risks associated with ESG.

Additionally, Toudouze said the SEC wants to see formal, documented policies and procedures, that firms have good controls, and that these controls are followed.

“The cornerstone of SEC regulation is clear and accurate representation. This is what the CCO needs to be focusing on,” Toudouze advised.

She also advised firms to avoid “greenwashing,” or the practice of conveying a false image to investors that a product is ESG-friendly.

“The SEC has indicated that this is going to be a very big focus,” she said. “I think what firms need to do is engage an outside party to review what they’re saying to make sure it’s consistent across all fund documents and communications. They also need to make sure they’re actually doing what they say they are doing and eliminate any inconsistencies.”

Toudouze noted that successful compliance programs include accurate disclosures and policies that appropriately conveyed material aspects of the firm’s ESG strategy.

“From a compliance standpoint, you want disclosures that are simple, clear, and precise. You want these disclosures to be tailored to the firm’s specific ESG strategy,” Toudouze commented.

To develop an ESG program that would stand up under SEC examiner scrutiny, Toudouze advises starting by assessing what the firm’s approach to ESG will be and identifying its program priorities.

“ESG is not ‘one size fits all.’ The ESG framework is really driven by a specific firm’s mandate and their obligations, if any, that they have to their stakeholders. That should be the first step in assessing your firm’s needs and goals for an ESG program,” Toudouze stated.

After that assessment, firms can craft a formal ESG policy statement. It should be a well thought out, broad-based policy statement that incorporates and mandates or obligations firms have to stakeholders, what the firm is doing in relation to ESG, how ESG is incorporated into the investment process, and how firms get relevant information from portfolio companies.

Finally, monitoring is an important, and essential, component of an ESG program. The SEC wants to see that firms are not only reporting the data but are being truthful about it. Toudouze said that in order to properly monitor ESG data and other key performance indicators, or KPIs, firms need proper technology.

“If you do all of the front-end work on ESG but you’re not able to monitor it, then you’re not fully dedicated to ESG and you’re not going to meet your goals,” she concluded.

Jennifer Banzaca

Jennifer Banzaca has been a reporter and editor covering the hedge fund industry for 14 years, most recently focusing on legal and compliance issues.
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