Recently, we looked at ESG initiatives that companies can take regardless of what any regulation may require. There’s another issue with ESG compliance, however, that stems from the veracity of ESG data reporting, or at least the reporting standards being used for that data. It’s known as “greenwashing,” when companies or funds misrepresent how environmentally sustainable their actions are – sometimes by highlighting certain facts and figures in a way that leaves a better impression than the reality.
Substantive Research, a buy-side analytics provider compared and contrasted the offerings of more than 140 ESG providers to show the choices that data consumers have, and to help them compare these sources and select the most appropriate ones for getting an accurate view of companies’ environmental sustainability.
ESG guidance and regulation is itself vague, and the minimums set in some standards may make no difference on greenwashing. Felix Goltz, a research chair at EDHEC, a European business school, says funds can “game” the systems of ESG ratings to get better sustainability scores without actually making their practices more sustainable. Funds that are touted as ESG funds often are comprised of investments that aren’t that different from regular index funds.
Where should investors and funds turn?
In 2020, the International Association for Sustainable Economy (IASE) set out 10 actions companies and funds should take, including making a corporate strategy for sustainability, making more financing available for ESG-conscious companies, making more work opportunities available in ESG operations, and including sustainability in corporate operations. This statement is guidance, but doesn’t quantify specific environmental goals and doesn’t have any enforcement power.
One organization that theoretically could enforce ESG standards, the U.S. Securities and Exchange Commission, has issued ESG guidance for funds and investors and some fact-finding work about ESG investment. However, SEC chairman Gary Gensler said in early September that the commission doesn’t have a scoring system for ESG, although it would try to develop more clarity about qualitative and quantitative ESG disclosures.
The EU, for its part, instituted SFDR (Sustainable Finance Disclosure Regulation), which took effect in March 2021. SFDR includes taxonomy regulation intended to define what activities are environmentally sustainable, but is still contending with varied methods of determining ESG scores, as we wrote in May. He added that ESG scores need to be checked more than just once a year, can fluctuate and should be monitored for straying from guidelines or mandates.
This reinforces the idea that for now, it’s left to investors who are concerned about ESG to scrutinize ESG scoring data and the methodologies and guidelines used to produce that data. Investors can ask companies to take certain steps, and lobby regulators for certain provisions, as partners from KPMG said in a recent webinar.
What investors can ask regarding greenwashing
Points that investors can ask companies include:
- Emphasize in their information what is truly company specific and value relevant.
- Focus on consistency and links between all aspects of their reporting.
- Improving systems, processes and controls to produce fit-for-purpose ESG information.
- Follow standards that are widely accepted, such as those issued by the Sustainability Accounting Standards Board.
- Ask for assurances about ESG disclosures that are relevant to value.
On the regulatory front, issues that investors should raise include:
- Making disclosure standards for ESG information mandatory.
- Using work done on voluntary frameworks as a basis for standards.
- Collaboration between regulators and reporting framework creators to get consistency in ESG standards.
If these areas of inquiry don’t go deep enough, there are some other questions you can ask to get some hard facts and hard numbers, according to Morningstar analyst Benjamin Joseph:
- Does your investment process screen out securities that are incompatible with mandates for sustainability?
- Do your ESG criteria include screening processes for position sizes and sector allocations?
- Does your risk management include ESG metrics?
- Does your operation source, collect and leverage ESG data?
As it stands, investors and funds will have to do their own fact-finding to ensure there’s no greenwashing going on within their ESG investments. Neither the U.S. nor the EU yet have a safety net of regulatory requirements for anyone to count on. As analysts, observers and researchers are saying, however, there are ways to evaluate ESG for oneself, but it’s more work and time intensive.