Regulators are stepping up their scrutiny over sustainability claims.
In late May it was reported that Deutsche Bank and its asset management subsidiary DWS are being investigated over allegations of greenwashing. In the same month the investment management arm of BNY Mellon received a $1.5m fine from the Securities and Exchanges Commission (SEC) for misstatements and omissions regarding ESG investment processes. Goldman Sachs is also reported to be under investigation by the SEC over its ESG funds.
As many readers will be aware, ‘ESG’ stands for ‘Environmental, Social and Governance’. While ESG is not a new concept, there has been intense interest in this subject in recent years as investors and companies are increasingly scrutinised on their wider impact on the world rather than just their ability to make money or provide goods and services. ‘Greenwashing’ is defined in a straight forward manner by the Cambridge Online Dictionary as ‘to make people believe that your company is doing more to protect the environment than it really is’. In essence, it is the making of unsubstantiated or misleading claims about the environmental benefits of a product, service, technology, or practice.
DWS is alleged to have claimed that ESG criteria was taken into account for more assets under management than may actually be the case. The fine levied against BNY Mellon Investment Adviser was due to representations made between 2018 and 2021 that suggested investments in the funds had undergone an ESG quality review at the time of investment, even though that was not always the case
So, what are the difficulties in establishing that greenwashing has taken place? Unlike investment returns which are a fairly well understood concept, ‘ESG’ is subjective and there is no universal, agreed definition of what makes a company ‘good’ or ‘bad’ from an ESG perspective. Nobody at the FCA or anywhere else for example says specifically that company A can be included as an ESG investment but company B cannot. Organisations, such as MSCI and Sustainalytics, have scoring systems, frameworks, and methodologies but these are not standardised. In the absence of universally agreed and accepted set of ESG definitions and metrics, asset owners, asset managers and investors use their own criteria in their ESG determination and application.
This is further compounded by the fact that whilst some factors may be quantifiable to some extent, others such as the impact of a coal mine closure on the local community are more difficult. Although there are rules which investment firms have to follow about not misleading investors, specific regulation covering sustainability claims and reporting is still in its relative infancy. In May 2021 the EU (but not the UK) introduced Sustainable Finance Disclosure Regulation (SFDR) in order to ‘improve transparency in the market for sustainable investment products, to prevent greenwashing and to increase transparency around sustainability claims made by financial market participants’. The proposed UK Sustainability Disclosure Requirements (SDR) will introduce a system of disclosures and a sustainable investment labelling system which will apply to listed issuers, asset managers and certain asset owners and the investment products they offer.
It should be remembered however that the SFDR categorisation of funds – whether Article 6 (those which are not promoted as having ESG factors or objectives) or Article 8 (those that promote certain environmental or social characteristics but do not have these as the overarching objective) or Article 9 (those which specifically have sustainable investment or carbon emission reduction as their stated objective) – is done by the fund management company. The burden of proof lies with asset managers and the recent actions suggest that if ESG claims can’t be substantiated then fund managers may find themselves in the regulatory firing line.
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