Whilst ESG investing is moving rapidly, greenwashing ultimately comes back to the intentionality behind the investment activity, writes Romil Patel.

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Sustainable portfolios are somewhat akin to trees – they take in the good, the bad and the ugly and in return, foster rich conditions for on-the-ground growth over a long-term time horizon. If planted incorrectly, however, the impacts could be detrimental to the surrounding ecosystem.

Companies and asset managers have been making grand net zero declarations over the past year which, at a headline level, bodes well, given the need to align financial flows with efforts to combat the climate crisis. Indeed, no fewer than 87 signatories with US$37 trillion (€30.5 trillion) in assets under management (AuM) have joined the Net Zero Asset Managers Initiative, pledging to support the goal of net zero greenhouse gas emissions (GhG) by 2050 or sooner to limit warming to 1.5 degrees Celsius; and to supporting investing aligned with net-zero emissions by 2050 or sooner.

Global leaders are also directly addressing the gravity of the climate crisis and setting out targets to address what US president Joe Biden termed as “the existential crisis of our time”. Marking the annual Earth Day event on April 22, Biden vowed to slash US carbon emissions by 50-52% (from 2005 levels) by 2030, while the UK aims to enshrine its climate change target to reduce emissions by 78% by 2030 (from 1990 levels) into law.

But in order to bring operations within the required planetary boundaries by 2050, there are a number of issues to address in the current real economy and the capital markets – and both investors and banks are a vital source for sustainable capital.

Last year was a record year for sustainable fund inflows as total assets in sustainable funds reached $1.7 trillion, according to Morningstar, but is that translating into operations and the way that an institution makes money? Are asset managers truly embracing sustainability supported by concrete targets, metrics and information to demonstrate their intentionality, or are they simply laundering their credentials by insidiously marketing a product or their services as something they are not – or in other words, greenwashing?

What are your intentions?
In order to determine whether greenwashing is occurring, it’s important to get into the weeds rather than trying to apply a blanket term, given that ESG still suffers from confusion in terms of what question we’re trying to answer.

“There are two questions – one is about impact, and one is about financial risk, and they get lumped in and confused, so it’s important to pull those things apart and whether something is or isn’t greenwashing depends on what they’re trying to greenwash about,” Michael Marshall, head of sustainable ownership at RPMI Railpen, tells Funds Europe. “Were they trying to pretend that they do good quality ESG risk management, or were they trying to pretend they’re having a positive impact on the world, or at least not a negative one? That is core.”

This leads us to intentionality and consistency, for the intentionality behind the investment activity is critical to understanding whether greenwashing is occurring or not.

“A manager who owns a company that has a higher environmental impact than another company, but is significantly reducing that impact and is engaged with the company to help drive positive change, and whose proxy voting record is consistent with that activity, is probably not greenwashing,” observes John Streur, president and chief executive at Calvert Research and Management.

“However, the manager who owns the other company that might actually have a slightly less environmental impact and isn’t paying attention to it at all but says that they are, and is not voting the proxies in a manner that is consistent with progress, with positive change, may be greenwashing,” adds Streur.

A key component of environmental justice is a just transition to ensure that jobs and economies do not come crashing down overnight whilst doing what lives within climate science. “We recognise there are a whole host of industries and companies which need to transition, but we don’t want them simply just to shut one thing down and put people out of work because that does not endear the various parties to work together,” says Emily Kreps, global director for capital markets at CDP.

“This is where the opportunity comes for investors to say: ‘I’m not going to divest, I’m not going to write you off, but what I need to see is that you’re operating in line with climate science, so setting a science-based target and committing to a transition plan that investors can vote on, or shareholders can vote on. We’re not going to write you off but you’re transitioning, and we need you to set concrete targets that are aligned with climate science to reach net zero by 2050,’” adds Kreps.

How does a responsible fund look?
ESG investing is a fast-moving area and the goalposts for greenwashing are fluid as standards increase and regulation kicks in – what constituted sustainable fund characteristics previously may no longer be valid.

“A year ago I would have said only exclusions, but now I would say if you only do exclusions and ESG integration and call yourself sustainable, you would be greenwashing,” says Masja Zandbergen-Albers, head of sustainability integration at Robeco.

A responsible fund should have standards that incorporate both environmental or social sustainability goals whilst weaving in the concept of financial materiality so that managers approach this from the perspective and within the purview that is appropriate for their role within the system as investors.

This underlines the importance of impact measurement and management, which may not necessarily solve greenwashing, but at least imply a commitment to transparency which will form the next chapter of responsible investing globally.

As well as a record number of global sustainable fund launches, repurposed funds reached a record high in 2020. Morningstar identified 253 such funds, “87% of which reflected the change by rebranding”. Common terms applied to rebranded funds included “sustainable”, “green”, “ESG” or “SRI”.

Here, it is vital to separate the endeavour of managing some sort of risk factor called ESG from the endeavour of launching or managing a sustainability fund which is targeting some sort of impact premium over some period.

A manager who claims to be great for the world just because they don’t invest in tobacco, oil and gas can expect to face questions around whether they are making a material difference, because ultimately someone else will own those shares. Funds must apply specific criteria to demonstrate sustainability credentials to avoid accusations of greenwashing. So, how does that look?

“We have a specific exclusion list and exclusion policy for a sustainable fund that is broader than our regular strategies,” says Zandbergen-Albers. “Then we also have at least a 20% lower footprint on water, waste and greenhouse gas emissions, a 20% better ESG profile or 20% negative screen, so we have very strict rules. If the fund manager says: ‘I want to rebrand my fund to become sustainable,’ then it’s very clear what he or she needs to do.”