ESG Honestly
Posted 16 February 2024
The end of greenwashing?
From May, ESG investments in the UK will have to comply with a stricter set of anti ‘greenwashing’ rules. Several were announced by the Financial Conduct Authority (FCA) last November, and the watchdog is now taking a consultation on its guidance.
It follows similar moves from the European Union to crack down on false or misleading claims about products’ or companies’ environmental credentials. Plans on information disclosure relating to ESG metrics were first agreed in June 2022, and an agreement on new rules governing environmental claims was agreed in September 2023. Then just last month, the European Parliament greenlit a ban on erroneous environmental labels.
After the EU’s initial agreement a year and a half ago, the French environment minister boldly claimed that “Greenwashing is over.” Politicians trying to sell the new rules or media reports bigging up the news have made similarly bullish comments over the years. Are they right?
That, of course, depends what exactly you mean by ‘greenwashing’. In the broadest sense, it is just a case of false advertising, specifically with consumers being misled over the environmental impact of the company or its products. It has become a big topic in the ESG investment world, but the basic problem applies to supermarket products as much as it does financial ones.
The label ‘biodegradable’, for example, means that a product will break down naturally over time – but there are usually few rules on how long that can take or specifying the conditions under which something will break down. The law that European Parliament passed in January is designed mainly to cover these sorts of cases. Lawmakers focused on the labelling of goods, warning that companies could no longer advertise a product as environmentally “good because the company planted trees somewhere”.
Greenwashed investments
When it comes to ESG investing, greenwashing claims – and what to do about them – are a little more complicated. Most often, it refers to ESG funds or portfolios including assets linked to companies (usually the company’s shares, but sometimes its bonds or otherwise linked assets) which are considered detrimental to the environment.
The stereotype is a fund manager picking oil or gas stocks because of those companies’ self-reported green targets. This can happen either because the fund manager’s ESG metrics are not adhered to, or because those metrics are themselves flawed and liable to manipulation.
These practices have unfortunately grown alongside the demand for ESG investments. And while investment professionals are usually not the biggest fans of too much regulation, greenwashing and the discussion around it highlights why so many are crying out for firm and consistent rules.
A recent report from researchers at ESSEC Business School showed that, following reports of greenwashing scandals or negative news coverage, institutional investors decrease their investments in green funds by 8% the following month, and retail investment drops by an even larger 12.6%. This disinvestment can be as much down to financial considerations as collective moral disillusionment. In September, Deutsche Bank subsidiary DWS was fined $19 million by the US Securities and Exchange Commission for ESG reporting failures.
Making green cleaner
These scenarios are more likely without clear rules and enforcement procedures. The FCA’s new rules and guidelines are designed to do exactly that. They require investment products to be labelled clearly and in a way that helps investors understand where their money is going, where those labels are based on clear sustainability goals and criteria.
The watchdog has said it will publish the results of its anti-greenwashing consultation sometime in early 2024. But it has already laid out a number of principles and guidelines for investment managers to follow. Any marketing claims about positive impacts or sustainability will have to stand up to scrutiny too. Investments labelled ‘green’ will have to have a measurable environmental benefit, and the managers of those investments will have to have a clear sustainable investing.
It is much too early to say whether these rules will mean an end to greenwashing for ESG investments – let alone in general. They are sure to have some impact, but the bigger impact will likely come from regulators’ tougher attitude than specific rules. That is not least because the rules and guidelines, while stricter than what came before, are still a little vague or open to interpretation.
A highly complex problem
In a sense, though, that is unavoidable. Measuring something’s environmental impact is inherently multi-dimensional, in a way that measuring its returns or risk factors is not. Aggregating over those dimensions to give a single ‘eco’ metric means making a plethora of decisions about which factors to trade off, where many of those decisions are controversial.
These problems are why many environmental groups advocate the removal of environmental labels or certifications altogether, and their replacement by comprehensive transparency rules. B Corp designations – a marker of social and environmental conscientiousness in more than 80 countries – have been heavily criticised over the years, for example, to the point where they are being seen as just one factor to consider in a broader approach.
The flipside of the argument, of course, is that giving businesses and consumers too much information will simply overwhelm them and turn people away from ESG investing. But while that is a problem to consider, it is not made any better by pretending the world – and the global environmental crisis we all face – is simple. Balance, clarity and transparency are, as always, the virtues to aim for. We hope the latest rules improve on those, even if they do not end greenwashing for good.