The proposals, which are open for public comment, detail how ESG funds should be marketed and how investment advisors should explain their reasoning when labeling a fund.
Regulators and activists are concerned that US funds seeking to capitalize on the popularity of ESG investing may be misleading shareholders about the underlying holdings of their products, a practice known as "greenwashing."
The new "Fund Names" proposal aims to increase the number of funds that must invest at least 80% of their assets in accordance with their names and investment policies.
According to an SEC official, the rule would cover approximately 75 percent of all funds, up from 62 percent currently, and would prohibit 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 primary focus is on ESG funds, which attracted a record $649 billion globally through November 30, up from $542 billion and $285 billion in 2020 and 2019, respectively, according to Refinitiv Lipper data.
According to Andrew Behar, president of the climate-activist group As You Sow, market participants have taken advantage of a loophole in the current rules when naming funds.
Other advocates, including Washington-based advocacy groups Public Citizen and the Sierra Club, have stated that a lack of market transparency makes it difficult for investors to determine how environmentally friendly some of these products are.
"Once finalized and implemented, these SEC rules should finally provide investors with consistent and reliable information they can use to decide which asset managers and funds truly align with their values and financial goals," said Ben Cushing of the Sierra Club.
The agency also proposed a rule on Wednesday that would increase disclosures for ESG strategies in fund prospectuses, annual reports, and advisor brochures.
According to SEC Chair Gary Gensler, the measures are in response to growing investor demand for such information.
"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."
However, industry groups have warned that the agency's goal of standardizing ESG labels may limit investor choice.
"We object to actions that would... substitute a regulator's judgment about investment strategy for that of professional fiduciaries," said Janay Rickwalder, an Investment Adviser Association spokeswoman.
The Managed Funds Association expressed hope that the new rules will recognize the variety of investment strategies that enable institutional investors, such as pensions, foundations, and endowments, to meet their ESG objectives.