The integrity of the ESG (Environmental, Social and Governance) investment principles are under threat; they are essential if we are to develop a more sustainable and equitable economy. Greenwashing refers to the process where companies convey a false impression of alignment with ESG objectives through marketing or public relations.
Many investors, both large and small, are easily susceptible to greenwashing as it is often difficult and time-consuming to check exactly what their money is funding. Without regulation on companies making unsubstantiated claims about their products' ESG positivity, there is a risk it will become just a marketing technique designed to attract a growing market of conscientious investors. To allow the ESG principles to be truly integrated into investment decisions, greater transparency is needed between companies and investors.
A shocking recent example of greenwashing in finance comes from Danish pensions and insurance provider PFA. The company is aiming for carbon neutrality across its investment portfolio by 2050 as part of the UN backed Net-Zero Asset Owner Alliance and claimed to support the agreed goals in the 2015 Paris agreement. However, PFA owns $187m in bonds funding tar-sands oil production in Canada's Alberta region, the second-largest owner of such bonds. It also owns $152m in bonds financing a coal powered plant in Vietnam.
This is obviously an extreme example, but it still points to the scale of the prevalent problem in a range of companies and investment funds. Another, only too common example of greenwashing in regular business operations came from IKEA last year. They were found to be fuelling their relentlessly growing wood consumption through illegal sources in Ukraine. IKEA has ambitious commitments to sustainability and was knowingly acting out of line with the values they preach in their sustainability statement. They aren’t alone; unfortunately, greenwashing is a widespread issue, and further regulation is needed to prevent more similar cases in the future.
It is not the specific act of investing unsustainably that is particularly disconcerting; the problem is the blatant misrepresentation of ESG that is currently allowed. Transparency is the key to changing the flow of capital to support activity that upholds these principles. Companies should be allowed to continue in coal fired power if they so choose; however, they should not be able to include such investments in cleverly labelled ESG funds to attract more investment from conscientious investors that are none the wiser. Many fund managers have been accused of just paying lip service to ESG principles by adding ‘green’ stocks and bonds to their portfolio without checking the true social impact they are having.
Morningstar data shows that there is a growing number of rebranded/repurposed funds in Europe, adding terms such as “sustainable”, “ESG”, “green”, or “socially responsible investment” to their fund title. This raises questions about the true credentials of these funds; have all unsustainable investments been redirected, or are we just yet to discover more similar examples of greenwashing in finance?
New ground-breaking regulation in the EU (that came into effect March 10th) aims to reduce the amount of greenwashing in financial markets by forcing agents to categorise investments as to their sustainability. Tough thresholds will have to be met for funds to be marketed as sustainable. This is sure to have a global reach the same way GDPR has. The majority of funds will want to be marketed in Europe and will therefore need to meet these new requirements. The new forced transparency on businesses will require them to report on issues such as their carbon footprint and labour rights. Clearing the currently muddy waters is sure to have an impact on capital allocation and lead to long term change in economic activity in favour of the ESG principles.
However, critics have argued that the regulation may lead to investors punishing companies even when they are making healthy progress on ESG issues. In my opinion, this is just the result of healthy competition. Just as investors will move capital away from poorly performing businesses in terms of profit, the new integration of ESG principles into investment decisions is forcing businesses to make the drastic changes that are needed to combat any ethical and environmental issues they have. Businesses that are unable to do this quickly and efficiently will lose out.
It is paramount that the transition to ESG is regulated so that its principles are not reduced to solely a marketing tactic with no real substance for change. This is especially important as large funds and companies seek to capitalise on an ever-growing market of conscientious consumption and investment.
Comments