02 Sep 2022
The risks of greenwashing
In the first of a two-part Q&A series, Bradley Davidson, ESG Lead at RBS International, explains the dangers of greenwashing for funds and investors.
What is greenwashing and what are some notable examples?
“Greenwashing is primarily a marketing-versus-impact conflict, where misleading, false, or unsubstantiated information is used to overstate the environmental impact of a financial institution or the activity in which it delivers.
“Greenwashing claims can generally be split into two categories. The first is where claims have been made with the best intentions but there have not been sufficient internal checks and balances to substantiate the claims; the second, seemingly more nefarious, is where entities make claims, either direct or implied, without the intention of delivering on those promises.
“The growing demand for environmental, social and governance (ESG) investments, paired with rapidly developing markets, may lead to an increase in the number of greenwashing claims unless regulators can outline clear boundaries for sustainable finance activity.
“With ESG assets on track to exceed $53trn (£44trn) by 2025 (Bloomberg Intelligence, 2021), avoiding greenwashing claims should be front of the mind for funds to ensure they remain credible and can access opportunities to generate value in the transition to net zero.
“I won’t comment on market examples, especially where investigations are in process, but I’m sure our readers are aware of the high-profile cases brought against financial institutions. The perceived risk of falling on the wrong side of greenwashing is materialising, and funds should ensure they are able to provide evidence for any sustainability claims delivered to the market, in the same way we’re accustomed to doing so with financial claims.”
What are the dangers from a fund’s perspective if it, or the companies in which it invests, overstate their environmental credentials, and are accused of greenwashing?
“Recent greenwashing claims have highlighted the litigation risk attached to making false or misleading sustainability claims. I expect that these cases are the first of many to come as regulators develop specific ESG disclosure and labelling standards, so funds need to pay attention to the direction of travel to protect their investors.
“However, in the short term, it’s important to note that one of the cases brought to light in the United States did not require specific greenwashing regulation to litigate. Instead, Section 34(b) of the [US] Investment Company Act – which prevents untrue statements of material fact to be used in registered documents – was referenced in regard to ESG statements. The financial impact of litigation has been largely immaterial to date, but I would expect the cost to increase rapidly as proposed requirements come into law.
“The growing demand for ESG investments, paired with rapidly developing markets, may lead to an increase in the number of greenwashing claims unless regulators can outline clear boundaries for sustainable finance activity."
Bradley Davidson, ESG Lead, RBS International
“I recognise that making investments with predicted environmental and social impacts is not a perfect science. We cannot predict the future, but we must ensure sufficient due diligence is conducted and that the assumptions or limitations around this assessment are highlighted alongside the intended outcome.
“Where the impact does not materialise, management actions should be considered to understand the causes, and funds should communicate any required amendments or tilts to investors. Transparency is key to avoiding greenwashing claims.”
As well as the regulatory risk, what are the reputational risks for funds engaged in greenwashing – could they lose discerning investors as a result?
“Investors face a multitude of options when deciding where to allocate their capital. I cannot speak on behalf of investors, but I expect the phrase ‘Fool me once, shame on you; fool me twice, shame on me’ is applicable here. Funds challenged with greenwashing claims may struggle to attract the same quality of investors or face a significant increase in the cost of capital.
“Furthermore, institutional investors such as pension funds are acting on behalf of their own stakeholders. We have witnessed an increase in demand for ESG-aligned investment, so institutional investors would face challenges if capital was not deployed in line with their stakeholders’ wishes.
“Investors recognise the financial impacts of climate change, including the importance of managing climate risk while identifying new opportunities to generate returns aligned to the net-zero transition. Greenwashing claims brought against a fund may indicate it does not sufficiently understand the impacts of climate change, which could place long-term investment at risk. This may have a compounding effect if existing investors have no appetite to support new funds and managers have lost credibility across the community.”
How can greenwashing affect society’s ability to achieve net-zero targets?
“Financial institutions receive the licence to operate from investors and other stakeholders. Retaining trust and credibility is vital for funds to continue to attract private capital and deploy it in line with the economy’s decarbonisation targets. Particularly in the context of the significant shift of public to private capital over the last decade, which places greater responsibility on funds and other financial institutions to accelerate the transition.
“COP26 highlighted the significant role that funds must play in delivering impact at scale, and an influx of greenwashing claims would no doubt erode their ability to do so. Investors are placing their trust in funds’ environmental credentials – particularly those labelled as ESG or climate funds – when choosing where to place their funding.
“Breaking this trust would affect not only those accused of greenwashing but the industry as a whole. Trust takes a long time to build but can be dissolved very quickly. If broken, it would place increased pressure on the action timelines required to prevent the worst impacts of the climate emergency.”
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