Greenwashing, a battle worth fighting

In a sign of the maturation of the sustainable investment industry greenwashing is moving up the agenda, with recent studies across developed markets highlighting this as a top risk identified by investment professionals for 2022. Yet, even if stricter regulations are now in place in Europe and if new accounting standards are planned, it is essential that the players in the industry discipline themselves to fight against this scourge. The very legitimacy of sustainable investment is at stake.

 In a sign of the maturation of the sustainable investment industry greenwashing is moving up the agenda, with recent studies across developed markets highlighting this as a top risk identified by investment professionals for 2022. Most will be aware of the recent allegations made by previous employees of both Blackrock and DWS, and with asset managers increasingly vocal about the sustainability of their funds, this concern is understandable.

Greenwashing is everywhere

Greenwashing is the dissemination of disinformation so as to present an environmental (and socially  responsible) public imagine and can relate to anything from a fund to a toothbrush; it is certainly not an issue just for the asset management industry. As consumers, buyers, regulators and governments become increasingly focused on improving the sustainability of the global economy, there is a growing number of bogus claims being made about the sustainability of products. In the investment world some of these claims are slight misrepresentations, others are purely scandalous.

The more scandalous examples include funds that with ESG or impact in the fund name without a sufficient strategy to support it, or those that don’t follow the process or restrictions outlined in their own marketing documentation. These are clear misrepresentations and regulators should not find it too challenging to identify them.

ESG and impact investments are often misunderstood

There is then the debate about which strategies count as sustainable. This feeds into recent greenwashing allegations surrounding what we believe is one of the biggest misunderstandings in the market; the difference between ESG and impact investments. Traditionally ESG investing has been about investing in companies that are best positioned to manage environmental, social and governance risks and benefit from related opportunities. For this approach it is about the impacts of the environment and society on the company, and it is more focused on the operations of a business rather than the product or service sold. A company managing ESG risk better than competitors can be considered sustainable even if its products do not help to solve a sustainability issue. Good management of ESG risks makes the company inherently more sustainable than a company that doesn’t, whether a manufacturer reducing reliance on scarce water supplies by recycling used water or a large employer committing to paying staff a living wage to support recruitment, retention and motivation.

Conversely, an investment made for impact is about considering the impact of the company on the environment and society. This puts greater emphasis on the product or service sold, and whether it is contributing to the achievement of a more sustainable society. This difference between ESG and impact appears to be misunderstood in the market, and it could be said that some asset managers are taking advantage of this misunderstanding to help raise assets.

Designations are helping but are not precise enough

The Sustainable Finance Disclosure Regulation which came into action in 2021 takes aim at this issue by requiring a great deal of disclosure of a fund’s sustainable approach to investment. Different designations are used to identify those that are pursing impact or “a sustainability objective” vs. those with “sustainability characteristics”. While in general this is good news, in practice Article 8, the designation for a strategy pursuing so-called sustainability characteristics, is at risk of becoming meaningless. Funds only considering ESG factors in their investment decisions are being designated as Article 8, putting it in the same category as an ESG best-in-class fund. We see it being used as a simple filter by asset owners looking for sustainable funds, when in practice it does little to identify those with a more rigorous approach. As a good example, we recently reviewed the funds available on Morningstar in Switzerland and found 54 China funds designated Article 8, many of which made no mention of sustainability in their prospectus. Other regulators have been more specific such as the AMF in France, where just a mention of ESG in marketing materials requires the fund ESG approach to meet a choice of three specific objectives. Regulators must find the optimum balance between preventing greenwashing vs. restricting the availability of different approaches.

Taxonomy will not solve everything

Finally, assuming there is a sufficient sustainable investment process in place for a fund, there remains the core debatable issue of what makes the investments held in the fund sustainable. One such debate is ongoing around nuclear energy, considered an important technology for the clean energy transition by some and harmful by others. For many companies the sustainability issues are less clear than this, more focused on operations than product sold and with a myriad of factors being analysed.

New accounting standards should bring more transparency

In addition, greenwashing is an issue at investee level, with extra-financial KPIs unaudited and often selected to show only the data that puts the company in a positive light. Many of these issues will start to be resolved by elements of the Sustainable Finance Directive in the EU, with accounting standards from the IFRS and continued campaigning from investors for better data.

Greenwashing is a threat for sustainable investments

While the existence of greenwashing demonstrates the need for more transparency, more data, and better oversight by regulators, the industry must be careful that it’s not considered a sign that sustainable investment is a marketing ploy and therefore meaningless. The very legitimacy of sustainable investment is at stake.