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      SEC ESG Audit Guide

      Preparation for ESG Audit

      How are you preparing for an audit around ESG investing?

      Though the SEC is not currently planning to dictate a formal definition of ESG investing, all advisors should be prepared to offer robust and auditable reporting based on their investment processes and methodology for ESG. 

      The SEC is starting to ask advisors about their ESG processes. Our guide helps you navigate common questions that may come up during an SEC ESG audit as well as offers a few extra tools to bolster your existing investment processes. 

      Steps to take when facing an ESG audit:

      • State definitions. What do you mean when you say ESG?
        • At YourStake, we often define ESG as aligning clients' investments with their values. You may use the term ESG to mean evaluating environmental, social, and governance metrics with the goal of financial outperformance. 
      • Provide a description of ESG criteria.
        • YourStake can aid you in defining ESG criteria. You can print out our most recent data dictionary or print out a PDF report to show which metrics you're using in client reporting. 
      • Provide copies of any written policies and procedures relating to the application of ESG criteria to the investment process.
        • Advisors apply ESG in many ways. One of the common ways that advisors apply ESG to their investment process is by using YourStake's fund screener to find funds with the best alignment to a particular client's values. You may also have a written policy describing how you use YourStake or other ESG tools to apply ESG criteria to your investment process. 
      • Provide documentation on ESG industry standards and how those standards influence portfolio construction, policies for how you adhere to the standards, and copies of applications, reports, evaluations, and policies associated with adherence.
        • Some industry bodies, like the Principles for Responsible Investment, require the production of a compliance report, which you can share with the SEC. You could also describe how certain industry standards, such as the UN Sustainable Development Goals, may influence your portfolio construction process. 
      • Provide a copy of any contracts or agreements with service providers that provide due diligence, screening information, or other services to your firm in connection with the use of ESG criteria in the securities investment process, including proxy voting.
        • You can find a copy of YourStake's terms of use agreement here. 
      • If applicable, communicate information about greenhouse gas (GHG) emissions in portfolio construction. Do you consider Scopes 1, 2, and 3? Do you communicate portfolio emissions to clients? For what percentage of holdings are GHG data available? How do you utilize GHG emissions (eg. total emissions, revenue intensity...)? Do you use estimates when actual emissions are unavailable?
        • If you use YourStake's Industrial GHG Emissions, Industrial GHG Emissions Intensity, or Cars Driven for a Year metrics, then you are using reporting on Scope 1 GHG emissions. YourStake does not use estimates when data is not available, which allows for the greatest level of accuracy and traceability. 
      • List all securities or any type of financial instrument (including cash and collateral) held in current and former client accounts, since the date the advisor became registered.
        • Include a) the ESG rating that was part of your process in selecting or monitoring the security, b) the specific metrics used for evaluation, and c) whether ESG criteria were a determinative factors for that investment. 
        • If you use YourStake to screen for funds, you may use the find's overall alignment with the metrics used to select the fund as the "ESG rating." For companies, you can export a spreadsheet from our company screener and use the "overall percentile" number as the ESG rating. 
        • You can copy and paste the values from our attribution pages to show raw data.
        • For advisors applying negative screens, you can note that the absence of a major flag was the reason why you selected the investment. 
      • Did you recommend clients divest from any investments for ESG reasons? DO you have documentation of the rationale for divesting? What were the five largest positions from which you divested?
        • You can take a screenshot of YourStake's company screener and/ or reporting pages to provide a rationale of why each company failed particular screens. 
      • What were the three most and least profitable investments that you made due to ESG reasons? 
        • Make sure this answer is consistent with information about process and whether ESG criteria were determinative factors for that investment. 
      • How do you incorporate ESG into your model strategies? Please include or identify existing records that contain these descriptions and explanations. 
        • The difference between model strategies and specific investments is how tailored the ESG criteria are to each client. While you may make investment devisions for a client's portfolio based on their values, it's also important to disclose how you choose to incorporate ESG into model strategies. Do you create multiple sleeves based on common values-categories (eg. climate sleeve, gender equity sleeve, etc.)? Others may use a different method for selecting which ESG criteria to apply across models. For example, some advisors develop broad ESG models based on top metrics on YourStake and other tools. 
      • Share all your materials that reference ESG
        • Be sure that any material that refers to ESG is tied to an internal process or discipline. For example, if you say, "ESG is considered for all investments firm-wide," you must have a documented process that backs this statement up. The SEC is starting to take notice of overly broad statements, which may invite regulatory scrutiny. 
      • Offer information on performance returns and, to the extent that you have it, analysis quantifying investment return relating to ESG matters, as well as quantifiable improvement in ESG factors
        • YourStake's metaphor metrics can help with the latter part of this audit request. 
        • Important note: YourStake's metaphor metrics are written in the form of, "Your portfolio is responsible for XXXX fewer chickens killed vs. the benchmark." YourStake is not saying that you are reducing chicken deaths by XXXX. We apply the ownership principle in assigning responsibility, meaning that if your client owns 1% of a company that slaughters one million chickens per year, that client is responsible for 1% (or 10,000) of the chickens slaughtered.