Coming Clean on Greenwashing
Mandatory reporting of standardized ESG data set to weed out false green claims from investments
Do the companies you invest in really contribute to a sustainable world, or are their "green" credentials simply marketing spin? That is currently the core issue for those investing based on environmental, social and corporate governance (ESG) criteria. According to two recent reports, authored by Morgan Stanley and Quilter respectively, while a full 85% of investors are interested in sustainable investments, 44% listed "greenwashing" as their biggest concern.
Greenwashing, a play on the term "whitewashing", is an attempt to make people believe that a company is doing more to protect the planet and its inhabitants than it actually is. The term originates from the 1960s when hotels first placed notices in hotel rooms asking guests to reuse their towels to save the environment, ultimately leading to healthy savings on laundry costs. As harmless as that example might seem, in today's environmental context especially, false claims can harm investor confidence and work as a barrier to essential sustainable development.
The problem is that both consumers and investors can be faced with sustainability claims from companies that are vague, containing narrow claims, with little proof or attention to full product life cycle. For instance, Nestle remains one of the top plastic polluters globally even after years of publishing “ambitions” to reach 100% recyclable or reusable packaging by 2025. BP, who famously rebranded as Beyond Petroleum, ran a series of adverts in 2019 focusing on their low-carbon energy products, at a time when it spent 96% of its annual budget on oil and gas. Even beacons of corporate responsibility like IKEA are not immune, as in 2020 its wood certification scheme failed to flag illegal logging in the Ukraine.
The investment fund industry can also fall foul of greenwashing and up until now most investigations have fallen to environmental groups or relied on whistleblowers. But as the market for ESG products and services rapidly expands, so does the need for stronger oversight by regulators. Just as regulatory scrutiny led to tighter financial accounting standards, greenwashing and the climate crisis have triggered the need for improved sustainability reporting. While voluntary international standards are available, no globally mandated ESG reporting rules yet exist. Europe has now taken the lead in this regard. As part of the European Commission’s Action Plan on Sustainable Finance, new obligatory reporting frameworks for both corporations and asset managers are being phased in over the coming few years.
For companies, the newly proposed Corporate Sustainability Reporting Directive (CSRD) will increase transparency, comparability and consistency of sustainable corporate performance. This would include data on topics such as carbon emissions, human rights and executive diversity. Among other requirements, it specifies that companies should report not just qualitative but quantitative targets and progress over a series of time horizons. In addition, green financial indicators must be disclosed in accordance with a classification system called the EU Taxonomy. This system, using science-based criteria, defines economic activities that significantly contribute to a set of 6 environmental objectives. Together, these measures will protect investors from greenwashing and allow them to investigate if a company’s ambitions translate to actual impact.
Many companies are already striving to publish such information, and while gaps still exist, it has allowed third-party ESG ratings firms to begin scoring and ranking them. Three of these providers, Refinitiv, MSCI and S&P Global, now release their universe of scores publicly. Unlike credit ratings agencies which most often agree on the credit worthiness of a company, the diverse methodologies employed by ESG ratings firms can lead to significant differences in company rankings. However, as ESG data quality converges, correlation and interpretability of remaining differences will improve.
The data reported via the CSRD will also serve as required input to another European reporting framework, the Sustainable Finance Disclosure Regulation (SFDR). The SFDR applies to asset managers and other financial market participants. It mandates disclosures on how ESG factors are integrated at both an organisational and product level. This covers published information in prospectuses, periodic reports and on websites. Investment funds will be labelled by how green their strategies are. It will also allow fund investors to understand what portion of their investment is aligned with the sustainability objectives of the Taxonomy.
Based on the current pattern of global growth in the sector, it has been estimated that ESG assets could top $53 trillion by 2025. This would represent more than a third of total projected assets at that time. It is vital that these investments are not misdirected by the blight of greenwashing. Policy and regulation such as those developed by the EU, provide investors with vital tools to help them ensure their money has the impact the world requires.
Darren Woods, Portfolio Manager, KBC Fund Management