At a glance
Greenwashing is not exclusively linked to misleading environmental claims for consumer goods, it applies to each and every sector, including the financial industry.
The financial sector is moving at pace towards integrating frameworks, screening processes and sustainable methodologies into its governance and daily operations.
As the paradigm shifts to sustainability to mitigate the multiple risks associated with climate, we are beginning to witness the reallocation of significant capital to ‘green causes’. The emphasis for a green economic recovery following the impact of coronavirus has entrenched the need to move towards ethical investments.
In his annual address to the world’s leaders, Larry Fink, CEO of Black Rock, lamented that climate change has brought us to “the edge of fundamental reshaping of finance.” This has been the trajectory of recent years, as he has continuously denounced the sole pursuit of shareholder value.
This has prompted an uptake of ESG related strategies to assess potential investments. To illustrate this, the value of global assets allocated to ESG related strategies sat at $30 trillion in 2018 versus $13.2 trillion in 2012.
In a previous article that discussed the role of sustainable finance in the race to net zero, I noted that 93% of the world’s largest 250 companies report on their ESG performance. The Global Initiative for Sustainable Ratings has identified that over 600 ESG products exist across the world from over 150 organisations. But, how many of these are greenwashing and providing unsubstantiated claims about the ‘ethics’ of their products?
In focus
Greenwashing in the financial industry
In a similar vein to the greenwashing of fast fashion’s ‘conscious’ collections, greenwashing has morphed into a substantial concern for the financial industry as ESG investing is increasingly endorsed.
The UK’s asset management regulator, the Financial Conduct Authority referred specifically to this type of greenwashing which is “marketing that portrays an organisation’s products, activities or policies as producing positive environmental outcomes when this is not the case”.
This can be hugely problematic for investors and financial institutions that issue green bonds. A green bond is a type of fixed-income instrument that is specifically allocated for climate or environment related projects.
There is a need for an agreed and standardised definition of what a ‘sustainable investment’ should be. For instance, strategies that merely apply exclusion criteria do not necessarily guarantee that funds are being used entirely ethically. In November 2019, the Wall Street Journal reported that eight out of ten of the biggest ‘sustainable’ funds in the US are invested in oil companies. Whilst these funds had applied exclusion criteria relating to guns, casinos and tobacco, they remain exposed to fossil fuel projects.
Identifying greenwashing in the financial sector can be contentious. Sébastien Godinot, Economist for the WWF European Policy Office calls for the distinction between ‘transition areas’ and ‘enabling categories’. In the first instance, an ‘enabling category’ would be a sector that covers wind turbine manufacturing but is not entirely sustainable throughout its life cycle. It is however, essential for building green infrastructure. Secondly, a ‘transition’ activity describes a sector where there is no alternative low carbon solution such as steel. Whilst no zero-carbon option exists currently, there are types of steel that produce significantly less carbon than others.
A final contention exists in determining what precisely is a ‘sustainable’ fund – this is based on the debates about whether nuclear power is a clean energy source or not.
How to identify greenwashing in the financial industry
Deciphering genuine ethical and sustainable options from greenwashed products is imperative to protect both consumers and investors. There are a number of bodies that work to regulate this investment space including the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), Sustainalytics and CICERO’s Shades of Green Methodology. The Shades of Green methodology in particular rates projects and solutions on a green scale. For example, dark green projects represent a long-term positive effect on carbon emissions such as wind energy projects with strong governance structures that account for environmental concerns. Contrastingly, the lightest shade of green acknowledges projects that are ‘climate friendly’ and offer a short-term reduction in GHG emissions. These light green investments often highlight a new technology that is better than the old one. However, they do not entirely eliminate negative impact on the environment. The case of innovative shipping technologies that increase efficiency but still produce carbon output illustrate this.
Steps for advisers to evaluate a fund’s ESG approach:
From my research, the below actions will help investors and those in the sector identify the ingenuity of funds ESG approach. These include:
- Demanding transparency, with clear simple information
- Being wary of marketing catch phrases that have little substance
- Reviewing the funds voting policies as well as voting history in general meetings. (Groups like ShareAction, report on the % of climate-related shareholder resolutions that funds have voted on)
- Collating information on the fund managers engagement priorities; whether that be racial diversity, protecting biodiversity etc
- Evaluating if the fund’s team live their beliefs through every day activism and research their track record. For example, do they fly around the world for unnecessary 1-hour meetings?
- Ensuring that the fund is wholeheartedly committed to staying on top of climate developments inside AND outside of the industry
EU Sustainability Taxonomy Regulation
Eliminating greenwashing of financial services requires stringent regulation. Until 2020, there were no distinct rules on which funds could be marketed as ‘green’. This meant that sustainably branded pension funds could still be funding weapons, pesticides or fossil fuels, with no penalties.
To rectify this monumental challenge, the European Union introduced the EU Sustainability Taxonomy Regulation which seeks to create a clear classification of green investments for informed decision making.
The introduction of this legislation is important to ensure that people are no longer sold fake, greenwashed investments and to direct funds to sustainable areas including renewable energy, in order to create wider societal value. It calls upon all stakeholders involved in the investment process including fund managers, issuers of bonds and listed companies to disclose how sustainable their funds are in reality.
The regulation has six key environmental objectives which compel the European Commission to implement screening criteria. These are:
- Climate change mitigation
- Climate change adaptation
- The sustainable consumption and protection of water and marine resources
- A shift towards a circular economy with an emphasis on waste reduction and an increase in the use of secondary raw materials
- Improvements to pollution prevention and control
- Enhanced protection of biodiversity and ecosystems
To address the climate emergency, the regulation draws specific parameters around what can be considered green in order to maintain the EU’s target to achieve 65% reduction in emissions by 2030. This is a critical science-based target for the region to achieve a 1.5 degree pathway. Such ruling implies that all fossil fuels, including natural gas should be excluded.
However, a limitation of the taxonomy is that whilst is outlines what sustainable and green activities are, it does not explicitly acknowledge unsustainable or ‘brown’ fossil fuel activities. The NGFS have called for an explicit list of brown sectors to be drawn into the taxonomy. The scope of this will be reviewed in 2021 in order to evolve into the advanced standard for green finance. In the interim, both Moody’s and MSCI have devised unsustainable taxonomies to guide their clients.
Finally, the taxonomy will help increase transparency and eliminate greenwashing. It calls for listed companies with over 500 employees to disclose and align their revenues, capital and expenditure to the regulations. How the United Kingdom’s departure from the European Union will impact its requirement to comply with the taxonomy is yet to be determined. This will undoubtedly impact the degree of trust investors can lend to ‘sustainable funds’.
If you enjoyed this article, take a look at my exploration into ethical banking.
The Rainforest Alliance Network’s 2020 report on ‘Banking on Climate Change’ is a useful resource.
You can also read more on greenwashing in the fashion industry here.
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