Environmental, social and governance (ESG) investing is one of the most important trends in investment management and is increasingly becoming a huge business.
The value of investments in financial products that claim to abide by ESG rules is US$35tn, as reported in The Economist, February 2022 edition. It quotes Bloomberg, which predicts this will pass US$50tn by 2025.
But can we trust that ESG financial products are true to the label?
When ESG financial products are not true to the label, it can be referred to as greenwashing. The term is a play on “whitewashing,” which means using misleading information to gloss over bad behaviour.
Are we victims of greenwashing?
Greenwashing calls attention to organisations using misleading marketing or public relations to deceptively claim that their products, aims and policies are ESG friendly. The term is applied to any organisation that advertises environmental credentials that are materially inflated or even in contradiction to actual practice.
There is a more specific use of the term greenwashing in the finance industry, which signifies organisations that misrepresent the extent to which a financial product or investment strategy is environmentally friendly, sustainable or ethical.
These two variations of greenwashing overlap when an ESG portfolio holds corporate equity or debt based on false claims of the organisation issuing that equity or debt.
“Generally, institutional investors across the world agree that the biggest barriers to making sustainable investments are concerns around greenwashing and a lack of common language and data on sustainability,” reported Schroders Institutional Investor Study, July 2021.
Evergreen Consultants, who assess the ESG credentials of managed funds, believe the incidence of “greenwashing” sits at around 5-10% of those carrying an ESG or responsible investing label.
Poor disclosure, on so many levels.
When constructing an ESG financial product or portfolio, the investment manager relies on the data a company discloses about its sustainability efforts, the corporate governance it has in place and how rating agencies use this data. In other words, ESG reporting is very much a data challenge.
Greenwashing can arise from the misrepresentation of ESG credentials at any stage of the investment process. This may result from misconduct or intentional misrepresentation, but greenwashing might also occur inadvertently.
There are no globally accepted standards for how ESG performance is measured and reported by companies or investment managers.
Whether an organisation’s activities or products meet certain environmental, social and governance standards can be subjective and misleading. Is the assessment on a particular activity or product, or is it about who the organisation is overall?
A commonly cited example is green bonds—are they really green?
Green bonds attract investors to their purpose of supporting environmental or social projects. Less considered are the ESG credentials of the issuing organisation. Should that be a factor for a superannuation fund, investment manager or individual investor when deciding whether to invest or not?
Also important to consider, is what the issuer might be associated with. For example, do they have links to fossil fuel businesses, or have poor labour practices?
Regulators are taking notice, and taking action.
We are seeing action in both areas of greenwashing by regulators worldwide.
In New Zealand, the Financial Markets Authority (FMA) released guidance in late 2020 on financial products incorporating non-financial factors, to protect investors from greenwashing.
“As demand for [ESG] financial products grows, we want to ensure that investors can be confident these products deliver what they promise,” outlines the FMA Disclosure framework for integrated financial products.
In Australia, the Australian Securities and Investments Commission (ASIC) issued an information sheet in June 2022 to help financial service organisations avoid greenwashing when offering or promoting ESG-related products.
In addition, the Australian Competition and Consumer Commission announced in March 2022, that it would closely scrutinise businesses that make environmental and sustainability claims as part of its compliance and enforcement priorities for 2022-23.
Regulatory bodies in the U.K., Europe and the USA have also strengthened their oversight of ESG disclosures and practices—and are taking action.
In May 2022, greenwashing hit the headlines when German law officials raided the offices of asset manager DWS and its majority owner Deutsche Bank as part of a greenwashing probe. A month later, the chief executive resigned.
In the same month, U.S. Securities and Exchange Commission (SEC) charged BNY Mellon Investment Adviser for misstatements and omissions about ESG considerations, which led to a $1.5 million penalty.
These are actions taken against investment managers. However, regulators are also taking action against corporate greenwashing.
The U.K. Advertising Standards Authority (ASA) is set to caution HSBC over “misleading” adverts displayed at bus stops last year that promoted its green credentials.
The ASA draft ruling said that consumers would conclude that HSBC was making “a positive overall environmental contribution as a company” even though it also finances companies with big carbon footprints. This is referred to as greenwashing by omission.
And if you think that is complex, be on the lookout for Bluewashing, Pinkwashing and Cloudwashing.
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Greenwashing by investment managers and superannuation funds can be intentional and unintentional. Unintentional Greenwashing can happen by not having a thorough understanding of what is lurking in the lower layers of complex investment structures and investment data. AlphaCert can be used to provide this view and help with challenges such as unintentional greenwashing.