Greenwashing describes a marketing-based approach to ESG practices, where a company or a financial institution claims to be sustainable without making appropriate changes to business operations. Greenwashing is a prominent issue in the ESG space, with numerous companies and investors attracting negative media attention for either failing to conduct their business sustainably or holding controversial stocks in their portfolios.

Vague terminology leads to misunderstandings and facilitates greenwashing

ESG investing is still in a developmental stage, lacking established common terminology, universal reporting frameworks or standards. Terms such as ‘sustainable’, ‘SRI’, ‘ESG’, ‘impact’ and ‘ethical’ investing are often used interchangeably in media and by finance professionals. Since these terms describe very different investment strategies, this can easily create confusion. For example, ESG integration (the most widespread ESG investment approach) can involve investing in companies with lower ESG scores or in controversial industries, depending on the outcome of the investment analysis. At same time, when using ‘ESG’, media outlets tends to assume a more exclusionary approach where ESG-labelled funds invest only in companies with spotless ESG performance or the ones focused on renewable solutions. The disconnect between these definitions of ESG investing make it difficult for the end investors to identify funds that match their preferences. It can also lead to accusations of greenwashing in cases where an ESG-labelled fund holds controversial stocks, such as tobacco or defence companies, even if those stocks fall in line with their chosen investment strategy. At the same time, unclear terminology allows some companies to make misleading statements on their ESG commitments.

Marketing-focused approach to ESG: part of the process?

The rising importance of ESG to the investor community prompted some companies to focus on heavily marketing their sustainability commitments. Numerous corporates and investors have been engaging in greenwashing, with companies producing glossy reports with little substance and investors rebranding their existing products under ESG or SRI labels. However, due to the growing awareness of the material risks and opportunities arising from ESG factors, more and more investors are closely integrating ESG into their decision-making processes. For example, 85% of investors responding to our White Paper have either adopted or are in the process of adopting ESG integration across their assets.

The growing pressure from investors prompted many companies to follow their marketing with tangible changes. May Jaramillo, European Head for Sustainable and Impact Banking at Barclays Investment Bank, commented on this process: “You see companies that started from thinking that all they have to do is put a little bit of money into the biofuel space, but soon after that their investors started coming out and asking – what is this going to do for your decarbonisation strategy? Are you aligned with Paris? Are those science-based targets? … Eventually, corporates will realise that lip service doesn’t work.”

Ongoing integration ESG by mainstream investors, corporates and regulators makes greenwashing increasingly disadvantageous

As the ESG space matures and becomes more transparent, greenwashing is becoming a dangerous game to play. The main drivers behind this is the increase in availability of ESG data and developing regulatory frameworks. Using the growing pool of ESG data, investors are developing new methodologies that allow them to easily detect companies that overstate their ESG performance. Robert De Guigné, Head of ESG Solutions at Lombard Odier Investment Managers, shows how investment analysis can be refocused to detect genuine change: “We’ve seen companies having oil spills and on the other side, communicating on the fact that they planted five trees in the middle of a village. …To avoid being misdirected, we look at ESG information through their relative importance to the company’s activity and on a more dynamic aspect. For example, if a company attends ESG conferences, this would be a consciousness type of information, if it has set carbon reduction targets, this would be an action type and if it has reduced its carbon emissions this would be a result. In our ESG scoring methodology, we will give more importance to result and action types of information to keep focus on tangible achievements.”

On the regulatory side, the newly introduced European sustainable finance regime takes an aim at greenwashing by directing capital towards genuinely sustainable activities. The Sustainable Finance Disclosures Regulation requires relevant financial institutions to disclose how they integrate sustainability risks into their investment processes, while the EU Taxonomy establishes a classification of sustainable activities and sets additional disclosure requirements for financial market actors and large public companies. The resulting stringent ESG disclosure regime, supported by common definitions, will create significant obstacles to greenwashing.

Even with these developments, presently, ESG data is far from transparent. The current challenges are particularly evident in the recent debacle concerning Boohoo, an online retailer whose ESG practices received a high rating before the issues with its supply chain came to light. This reflects the existing gaps and imperfections in ESG data, as well as difficulties in ensuring its accuracy. At the same time, these difficulties are typical of a fast-changing arena, where methodologies and frameworks are in the process of being established. Armin Peter, Head of Sustainable Banking EMEA at UBS, reflected on the existing issues with ESG: “Looking at one rating does not mean you are covering the entire concept of ESG in the right way. The ESG space is still in its infancy, regulation has just recently fully engaged with it and started to impact the market; there are different reporting standards… Everyone is hoping for standards. This is typical for a transitional topic because everyone wants to understand what the endgame is, what do we aim for. On that part, you need to be a little bit more patient.”

Despite the existing challenges, ESG factors are growing in importance and becoming increasingly influential in all areas of finance and business transactions. ESG performance is now integral to attracting equity investors, debt finance (for example, green bonds or sustainability-linked loans), bank loans and M&A transactions. As a result, companies that overstate ESG their credentials will face negative consequences which might include legal liabilities when greenwashing comes to light. Lucian Firth, Partner at Simmons & Simmons commented on the evolution of the ESG space: “There is a tendency for people to overemphasise green credentials that external stakeholders want to hear about. People have to be careful because before, sustainability was something that was put aside in a CSR report that no one really paid attention to. Now it is very much something that corporates and asset managers are focusing on. If a corporate or an asset manager is found to have misled people, they will use that as a lever, particularly if money has been lost. I think people need to take their ESG disclosure very seriously in a way it wasn’t before. Before, people might have overemphasised what they were doing, but now they need to make sure it’s genuine and it can be substantiated. Because if they do not, there is a risk of litigation.”

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