Greenwashing and net zero leadership

Greenwashing is a regulatory, litigation and reputational risk that is only increasing in importance. Accusations of greenwashing, and guidance on how to avoid it, are being issued by prosecutors and regulators around the globe with increasing regularity. This is in direct correlation with the massive expansion of the sustainable finance market and claims made by it. This article will first cover ASIC’s information sheet 271 on how to avoid greenwashing and take a look at why DWS and Goldman Sachs were recently left vulnerable to accusations that they misled their investors in relation to green products. Yet, perhaps the biggest claim of all is the $132 trillion of capital now “committed” to net zero. Given that, the second half of this article will explore what actions leading investors could take to minimise the risk of being accused of greenwashing in a net zero context.

So what has been happening in the market?

In May 2022 German prosecutors raided asset manager DWS (majority owned by Deutche Bank). This was in response to a whistle-blower allegation that DWS had mislead investors when it overstated the degree of ESG integration it undertook in a prospectus. Specifically, the prosecutors said they had evidence that ESG factors were only taken into account in a minority of investments.

In June 2022 the US Securities and Exchange Commission (SEC) announced an investigation into Goldman Sachs asset management over claims it made in relation to its ESG funds. Specific details of Goldman Sachs ESG investment processes that are under investigation are not yet known. This comes after the SEC announced a proposed update to rules for clarity in naming ESG funds to mitigate against investors being misled.

ASIC is watching

Claire LaBouchardiere, a senior executive from ASIC, stated at the Investor Group on Climate Change (IGCC) conference on 16 June 2022 that ASIC is “very focussed” on the DWS and Goldman Sachs actions and that “ASIC would consider taking enforcement action in Australia where the conduct is egregious”. However she also stated that investors had been cooperative with ASIC to-date and that enforcement is “only one of the options in ASIC’s toolkit”.

Ms LaBouchardiere went on to explain that the ASIC Information note 271 (released [two] days ago at the time of writing) entitled “How to avoid greenwashing when offering or promoting sustainability-related products” does not contain any new law. It draws on existing policy around good disclosure and is intended to “help navigate the existing regulatory landscape” around greenwashing.

So what is greenwashing?

Greenwashing is another one of those sustainability terms that has been ill-defined and can mean different things depending on the context. In this regard the ASIC information note 271 provides welcome clarity to local investors looking to avoid the accusations levelled at DWS and Goldman Sachs. ASIC’s information note recommends that entities ask themselves 9 questions when issuing a product or service to avoid greenwashing:

• Is your product true to label?
• Have you used vague terminology?
• Are your headline claims potentially misleading?
• Have you explained how sustainability-related factors are incorporated into investment decisions and stewardship activities?
• Have you explained your investment screening criteria? Are any of the screening criteria subject to any exceptions or qualifications?
• Do you have any influence over the benchmark index for your sustainability-related product? If you do, is your level of influence accurately described?
• Have you explained how you use metrics related to sustainability?
• Do you have reasonable grounds for stated sustainability target? Have you explained how this target will be measured and achieved?
• Is it easy for investors to locate and access relevant information?

The process of working through the above questions are intended by ASIC to help an entity clarify that it has a “reasonable basis” for making a sustainability claim and to clearly communicate this to end investors so that they are not misled.

Consistent with the ASIC information note, we find greenwashing typically occurring in one of the following circumstances:

1. Mislabelling has occurred: A product or service is mislabelled or poorly understood. For example a fund might be labelled as “impact” when in fact it merely takes into account ESG factors as non-binding pieces of information in the investment decision making process. To that end, given ESG integration is by far the most mainstream of all sustainable investment approaches, yet is not designed to achieve real world positive outcomes, it is not surprising that claims of greenwashing are increasing.
2. Lack of follow through has occurred: The impact of a “green or sustainable” practice has been publicly exaggerated. Some entities may make a public “green or sustainability” commitment but subsequently fail to direct adequate expertise or resources to make good on that commitment. This type of greenwashing usually goes hand in hand with considerable marketing hype which compounds the issue.
3. Exaggeration or deliberate deception has occurred: For example, a company that has an overall negative impact on people or planet creates a sustainable or green product or service and leads the public to believe that this product or service is representative of the company’s full impact on people and planet. This is not to be confused with companies that are heavy emitters today but are instituting “green or sustainable” programs with a genuine intent to transition their entire business model for positive outcomes on people and planet. These types of brown companies transitioning to a low carbon world are absolutely essential to achieving net zero.

Ultimately, if an investor uses its own answers to the nine ASIC questions to be clear that it has not mislabelled a product or service; has followed through on all its promises with adequate resources and expertise; and has not made exaggerated or deceptive claims it cannot support, the risk of being accused of greenwashing is minimised.

Where does net zero fit in?

This article is written against the backdrop of USD$132 trillion of assets now committed to “net zero”. ASIC have stated that in relation to net zero claims “making clear what is a reasonable basis for the net zero claim is really important”. So what does that net zero commitment entail? What are the actions available to an institutional investor to make good on this commitment and avoid the litigation, regulatory and reputational risk of greenwashing? I recently joined a group of leading European and American asset owners at the Sustainability in Practice conference held by Conexus at Cambridge University to discuss exactly this question. The rest of this article sets out what approaches those asset owners agreed were best practice and, if taken, are a good start at providing a “reasonable basis” for making a net zero claim in 2022.

1. Shift approach from ESG risk to real world outcomes
   Some of the more flamboyant voices in the room stated “RIP ESG” not saying that taking ESG factors into decision making was dead but that it was now considered business as usual. There was consensus amongst asset owners that ESG integration is a necessary but not sufficient component to achieve their net zero commitments. To rely on ESG integration in order to achieve the outcome of a net zero world does not make sense as that is not the tool for which ESG integration as an investment style was created.
2. Clear top-down real-world outcome goals that flow to policy and procedure
   It was agreed that a clear and documented view was needed from the board and senior management of what real world outcomes an entity is trying to achieve and have this flow through to portfolio construction, manager selection and stewardship programs.
3. From low carbon strategies to net zero portfolios
   There was a general acknowledgement in the room that a low carbon strategy in one asset class of a portfolio is unlikely to result in a reduction of carbon in the real world. To that end, investors appreciated that engagement with the entire economy on the transition is key and asset owners were grappling with how this might best be balanced with short term carbon reduction targets
4. Engagement programs could be the new greenwashing
   Claims made about engagement programs are hard to verify and success often is a collaborative effort as opposed to attributable to one entity. Nonetheless it was deemed that understanding the transition trajectories of all assets in a portfolio was the first step. This is increasingly available as physical asset mapping data products come to market. It was agreed that engagement programs should be underpinned by clear objectives,communication of those objectives to companies and escalation methods when the company does not meet the expectation is key. The leaders in engagement are contributing significant resources and deep subject matter expertise to collaborate with each other to engage not just with a single company but to clear industry impediments to achieving net zero.
5. Make an attempt to measure real world outcomes across entire portfolios
   There was agreement that measuring real world outcomes is key to improving them. It was accepted by the room that equities is the easiest place to start with the data being most mature there. However, there was an expectation that private markets would become easier to measure over time. This is especially true in Australia as ASIC encourages private markets to undertake TCFD reporting.
6. Fiduciary duty is not an excuse for inaction
   Freshfields presented their “Legal framework for impact” to unpack the legal basis of action for Boards. The report looked at 11 jurisdictions to shed some light on the question of whether directors of funds were permitted to take real world impact into account in investment decision making and stewardship efforts. The report found that fiduciary duty in all 11 jurisdictions extended to permit (and in some cases requires) the pursuit of real world outcomes where the achievement of real world outcomes could be linked to financial outcomes. The evidential link between real world outcomes and financial outcomes was acknowledged as an evolving space with climate being the easiest to evidence, and natural capital expected to become easier to price as TNFD reporting rolls out.
7. From discrete topics to interconnected themes
   Most asset owners in the room who had made net zero commitments were also trying to address how to improve real world outcomes for biodiversity, nautral capital and human rights in their portfolios. There is an expectation that TCFD, the voluntary framework for reporting carbon emissions, will extend to the measurement of natural capital (TNFD) in 2023 and social capital (TIFD) later this decade.

It is important to note that best practice was expected by all in the room to continue to rapidly evolve so will need to be regularly revisited and reviewed by entities who have made net zero claims.

Conclusion

ASIC’s latest guidance on how to avoid greenwashing echos sentiment of its regulatory peers internationally. Australia’s recent federal election has been dubbed “the climate election” and community appetite for climate leadership has never been stronger. In this context investors should feel empowered not just to “avoid greenwashing” but to raise ambition and lead in the rapid transition to a low-carbon regenerative economy that Australians need to thrive.

Sustainability at JANA