Greenwashing: Navigating the Risks in Asset Management
Greenwashing broadly refers to the practice of making false or exaggerated claims about environmental benefits to deceive investors into believing that a fund is more environmentally friendly than it actually is. This can create a misleading impression of the investment fund’s environmental efforts and sustainability practices.
The exact definition of greenwashing is subject to interpretation and can vary between different products, services, industries, sectors, and jurisdictions. Despite this, the rise in ESG investing has increased concern over “greenwashing”, as more companies and funds are required or expected to disclose the environmental impact of their activities and investments.
- If the asset manager's greenwashing leads to financial losses for investors, they may allege misrepresentation, fraud, or breach of fiduciary duty which could leave the manager potentially insolvent and the fund exposed;
- Many jurisdictions have laws and regulations governing environmental claims and advertising. Greenwashing can violate these laws, leading to potential regulatory actions or claims against the asset manager;
- Rivals may challenge a fund's green claims if they believe they are false or misleading. This can lead to legal actions and/or regulatory complaints;
- Investors who believe that greenwashing has or could harm their reputations may seek early redemptions which the fund cannot manage, threatening its liquidity.
To mitigate greenwashing risks, asset managers should be transparent and accurate in their environmental claims. These should be backed up with verifiable data and certifications from reputable third-party organisations. Furthermore, given the lack of consistency in defining “green” investments, it is essential for fund managers to ensure they keep up to date with relevant disclosure and industry standards to ensure that they do not inadvertently engage in greenwashing. This can be achieved by ensuring they have sufficient knowledge or receive appropriate advice from experts.
Despite the litigation, regulatory, and reputational risks with greenwashing, there will still be asset managers who, knowingly or unknowingly, make misleading statements in respect of the “green” impact of their activities and investments. This raises the question as to how investors can mitigate their exposure risk to greenwashing. Navigating the risks of greenwashing requires investors to be diligent and well-informed by:
- Familiarising themselves with commonly used terms in sustainable finance, green investment criteria, impact investing, and sustainable investing. Understanding the differences between various investment approaches and strategies can assist with identifying misleading claims.
- Continuously evaluating the investment strategy and philosophy of the asset manager, as well as looking for transparency regarding their ESG integration process, methodology, and screening criteria for investments. A robust and well-defined investment strategy can indicate a genuine commitment to sustainability.
- Inquiring about specific examples of how ESG considerations influenced the investment selection, risk management, and engagement. A credible asset manager should have a systematic and well-documented approach to ESG integration.
- Scrutinising claims made by asset managers about the environmental or social impact of the investments. Looking for evidence that their investments align with stated sustainability goals. Asking for data, reports, or case studies that demonstrate the measurable positive impact of the investment decisions can avoid falling for misleading claims.
- Investigating the asset manager's track record in sustainable investing by reviewing their past investments, performance, and consistency of ESG integration. This can be further enhanced by seeking independent assessments or rankings that evaluate the sustainability practices of asset management firms.
- Selecting asset managers who have obtained independent certifications, such as the Principles for Responsible Investment (PRI) or the B Corporation certification. These certifications can provide assurance that the asset manager has met certain standards of sustainability and responsible business practices.
- Pushing for transparent reporting, as it is crucial for assessing an asset manager's commitment to sustainability. This can be facilitated by looking for regular sustainability reports or ESG disclosure documents that provide detailed information about the asset manager’s investment approach, holdings, and impact metrics. Transparency provides comfort to investors by demonstrating accountability and a commitment to providing accurate information.
- Reaching out to the asset manager directly to ask questions about their sustainable investment practices. It is essential to inquire about their voting and engagement activities with portfolio companies, as active ownership is an essential component of sustainable investing.
- Keeping up to date with industry standards and best practices in sustainable investing with initiatives like the Global Reporting Initiative (GRI), Task Force on Climate-related Financial Disclosures (TCFD), and Sustainability Accounting Standards Board (SASB).
With the rapid rise of ESG investing, greenwashing poses an increasingly more prevalent threat with severe implications for asset managers and investors alike. Communication between all stakeholders thus becomes imperative in ensuring alignment of their interests. Such communication cannot be achieved without the cooperation and active support of all parties.