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On May 25, the Securities and Exchange Commission (SEC) proposed amendments to rules and forms under the Investment Company Act of 1940 and the Investment Advisers Act of 1940 to require registered investment companies, registered investment advisers and exempt reporting advisers to provide additional information regarding their environmental, social and governance (ESG) investment practices. The proposed rule and form amendments are designed to create a “consistent, comparable and decision-useful” regulatory framework for ESG investment companies and advisory services, with consistent standards for ESG disclosures that allow investors to make informed decisions as they compare various ESG investments.

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The SEC is not proposing to define ESG or similar terms. Rather, it is proposing to require a fund to disclose to investors how it incorporates ESG factors into its investment selection process and investment strategy. The proposed disclosure would follow a layered approach, with a concise overview in the fund summary and more detailed disclosure in the statutory section of the prospectus.

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A fund that considers ESG factors in its investment process would be required to self-identify as an Integration Fund, ESG-Focused Fund or ESG Impact Fund based on how significant ESG factors are to the fund’s strategy. The amount of disclosure required would vary depending on the type of ESG fund.

These funds consider one or more ESG factors alongside other non-ESG factors in their investment decisions, but those ESG factors are generally no more significant than other factors in the investment selection process, such that ESG factors are not determinative in deciding to include or exclude any particular investment in the portfolio.

ESG disclosure for Integration Funds would be more limited than for ESG-Focused Funds or ESG Impact Funds. The proposed amendments would require an Integration Fund to briefly describe in the prospectus summary section how it incorporates ESG factors into its investment selection process. The SEC is not proposing more extensive disclosure requirements in the statutory prospectus because it is concerned that doing so could overemphasize the role ESG factors play in the fund’s investment selection process. However, an Integration Fund that considers the greenhouse gas (GHG) emissions of companies in which the fund invests as one ESG factor in the fund’s investment selection process would be required to describe how the fund considers the GHG emissions of its portfolio holdings.

Identify "in a few sentences" ESG factors considered by the fund and briefly summarize how they are incorporated into the fund's investment selection process.

A fund that considers GHG emissions as one ESG factor in its investment selection process must describe how it considers the GHG emissions of its portfolio holdings. This disclosure must include a description of the methodology used to consider portfolio company GHG emissions.

Summary Prospectus Disclosure <a href="#footnote1">[1]</a>

Statutory Prospectus Disclosure <a href="#footnote2">[2]</a>

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This type of fund focuses on one or more ESG factors by using them as a significant or main consideration in selecting investments or in its engagement strategy with the companies in which it invests. ESG-Focused Funds include:

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An ESG-Focused Fund (including an ESG Impact Fund) would be required to provide a proposed ESG Strategy Overview Table at the beginning of the Risk/Return section of its summary prospectus and other more detailed disclosure regarding its ESG investment practices in the statutory prospectus.<a href="#footnote4">[4]</a>&nbsp;The ESG Strategy Overview Table would require an ESG-Focused Fund to disclose the following information in a tabular format:

The concise disclosure provided by the fund in the ESG Strategy Overview Table would be complemented by additional information in the statutory prospectus.

In addition to the proposed amendments to fund prospectuses, the SEC is proposing several amendments to the annual reports of ESG-Focused Funds and ESG Impact Funds to provide additional ESG-related information. The proposed disclosure would be included in the management discussion of fund performance (MDFP) section of the fund’s annual shareholder report. The proposed disclosures for ESG-Focused Funds would include:

Provide key information about the fund’s consideration of ESG factors in a standardized ESG Strategy Overview Table.

Describe how the fund incorporates ESG factors into its investment process, including (i) the methodology for any index the fund tracks; (ii) any internal methodology used and how that methodology incorporates ESG factors; (iii) the scoring or ratings system of any third-party data provider used by the fund, including how the fund evaluates the quality of such data; (iv) the factors applied by any inclusionary or exclusionary screen; (v) a description of any third-party ESG frameworks the fund follows as part of its investment process; and (vi) a description of specific objectives of any engagement, whether by proxy or otherwise.

If proxy voting is a significant means of implementing the fund’s ESG strategy, disclose the percentage of ESG voting matters during the reporting period for which the fund voted on ESG matters. Cross-reference (and for electronic versions of the shareholder report include a hyperlink to) the fund’s most recent Form N-PX filing. If the fund uses ESG engagement as a significant means of implementing its ESG strategy, discuss its progress on any key performance indicators, disclose the number or percentage of issuers with which the fund held ESG engagement meetings, and indicate the total number of ESG engagement meetings. If the fund considers environmental factors in selecting portfolio companies in which to invest, disclose the aggregated GHG emissions metrics of the portfolio.

This type of fund seeks to achieve a specific ESG impact or impacts. ESG Impact Funds would be a subset of ESG-Focused Funds but would be distinguished from other ESG-Focused Funds by their stated goal of pursuing a specific impact(s). Examples include:

An ESG Impact Fund would be required to provide the disclosures proposed for all ESG-Focused Funds but would also be required to provide an overview of the impact(s) the fund is seeking to achieve and how the fund is seeking to achieve the impact(s). The overview must include:

The requirement for a fund to disclose the relationship between the impact(s) it is seeking to achieve and financial returns is designed to require funds to disclose, if true, that financial returns are secondary to achieving the fund’s stated impact(s) – or conversely, that achieving the fund’s stated impact(s) is intended to enhance financial returns.

In addition to disclosure in the ESG Strategy Overview Table, the SEC proposes requiring an ESG Impact Fund to disclose in its investment objective the ESG impact(s) it seeks to generate with its investments.

In addition to the proposed amendments to the annual shareholder report requirements for all ESG-Focused Funds, the SEC is proposing to require an ESG Impact Fund to discuss in the MDFP section of the fund’s annual shareholder report its progress on achieving its impact(s) in both qualitative and quantitative terms. An ESG Impact Fund would also be required to discuss the key factors that materially affected the fund’s ability to achieve its impact(s).

Provide key information about the fund’s consideration of ESG factors in a standardized ESG Strategy Overview Table. Disclose in the fund’s investment objective the ESG impact(s) the fund seeks to generate with its investments. Provide an overview of the impact(s) the fund is seeking to achieve and how the fund is seeking to achieve the impact(s), including (i) how the fund measures progress toward the stated impact(s); (ii) the time horizon used to measure that progress; and (iii) the relationship between the impact(s) the fund is seeking to achieve and the fund’s financial returns.

If proxy voting is a significant means of implementing the fund’s ESG strategy, disclose the percentage of ESG voting matters during the reporting period for which the fund voted on ESG matters. Cross-reference (and for electronic versions of the shareholder report include a hyperlink to) the fund’s most recent Form N-PX filing. If the fund uses ESG engagement as a significant means of implementing its ESG strategy, discuss its progress on any key performance indicators, disclose the number or percentage of issuers with which the fund held ESG engagement meetings, and indicate the total number of ESG engagement meetings. <a href="#footnote8">[8]</a> If the fund considers environmental factors in selecting portfolio companies in which to invest, disclose the aggregated GHG emissions metrics of the portfolio. Summarize the fund’s progress on achieving the impact(s) described in the prospectus in both qualitative and quantitative terms during the reporting period, and the key factors that materially affected the fund’s ability to achieve the impact(s).

Under the proposed rules, a registered fund that indicates it incorporates ESG factors would be required to report, among other things, the type of ESG strategy it employs; the ESG factors it considers; and the method it uses to implement its strategy. A registered fund would also be required to report whether it considers ESG-related information or scores provided by ESG providers in implementing its investment strategy, including the name of such ESG provider. The SEC, in its efforts to better assess the trends in this market, would also require registered funds to disclose whether they follow any third-party ESG frameworks and include the names of such frameworks.

The proposed form amendments also would require investment advisers that consider ESG factors in their investment analysis to include certain additional information as part of their Form ADV. A registered investment adviser required to deliver a firm brochure and one or more brochure supplements would be required to make ESG-related disclosures in its Form ADV Part 2A. The proposed amendments would also require both registered and exempt reporting advisers to make ESG disclosures in Form ADV Part 1A and applicable schedules.

Rule 204-3, the “Brochure Rule,” requires registered investment advisers to provide clients and potential clients with a brochure and one or more brochure supplements that reflect the adviser’s entire business, which may include multiple advisory services, investment strategies and methods of analysis.

Under the proposed rules, a registered investment adviser would be required to add the following ESG disclosure to its brochure and brochure supplements if the adviser considers ESG factors as part of its advisory business:

Both registered and exempt reporting advisers would be required to expand the information disclosed in Form ADV Part 1A related to the advisory services provided to separately managed accounts (SMAs) and certain private funds. The following ESG disclosures would be required under the proposed amendments:

Additionally, advisers that sponsor wrap fee programs will be required to provide a description of what ESG factors they consider and how they incorporate the factors under each program. Advisers would be required to describe any criteria used to assess a portfolio manager’s application of the ESG factors. If an adviser evaluates a portfolio manager’s application of ESG factors, it would be required to provide an explanation of whether it reviews, or whether a third party reviews, and the nature of such review. If no such evaluation is completed, the adviser would be required to make an affirmative statement that no such evaluation is completed and/or that the portfolio manager’s application of the relevant ESG factors may not be calculated, compiled, assessed or presented on a uniform and consistent basis. If the adviser serves as a portfolio manager to a wrap fee program, it would be required to include the disclosures in Item 8 (discussed above) as well.

Michael V. Wible 614.469.3297 <a href="mailto:Michael.Wible@ThompsonHine.com">Michael.Wible@ThompsonHine.com</a>

Andrew J. Davalla 614.469.3353 <a href="mailto:Andrew.Davalla@ThompsonHine.com">Andrew.Davalla@ThompsonHine.com</a>

Tashia Love 614.469.3284 <a href="mailto:Latashia.Love@ThompsonHine.com">Latashia.Love@ThompsonHine.com</a>

This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel. This document may be considered attorney advertising in some jurisdictions.

<a id="note1"></a>[1] This information would be disclosed as part of a closed-end fund’s general description of the fund.

<a id="note2"></a>[2] For closed-end funds, this disclosure would appear later in the prospectus.

<a id="note3"></a>[3] A fund’s use of advertisements or sales literature that mention ESG factors, but not as a “significant or main consideration” in the fund’s investment or engagement strategy, would not alone cause the fund to be an ESG-Focused Fund.

<a id="note4"></a>[4] A closed-end fund would provide the table at the beginning of the discussion of the fund’s organization and operation.

<a id="note5"></a>[5] A fund would check the box for proxy voting or engagement with issuers (or both, as applicable) only if it is a significant means of implementing the fund’s ESG strategy, i.e., the fund regularly and proactively votes proxies or engages with issuers on ESG issues to advance one or more particular ESG goals the fund has identified in advance.

<a id="note6"></a>[6] Examples of third-party frameworks include, among others, the United Nations Sustainable Development Goals and the United Nations Principles for Responsible Investing.

<a id="note7"></a>[7] An “ESG engagement meeting” is a substantive discussion with an issuer’s management advocating for one or more specific ESG goals to be accomplished over a given time period, where progress that is made toward meeting such goal is measurable, that is part of an ongoing dialogue with the issuer regarding this goal. If personnel of the fund’s adviser hold an ESG engagement meeting with an issuer on behalf of multiple funds advised by the adviser, each fund for which the meeting is within its ESG strategy may count the ESG engagement meeting.

<a id="note8"></a>[8] See note 7.

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SEC Proposes Standardized ESG Disclosure for Funds and Advisers

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