SEC Targets Greenwashers To Bring Law And Order To ESG
Regulators are placing emphasis on climate risk, and scrutiny of those who would exploit the global crisis for profit. SEC Targets Greenwashers To Bring Law And Order To ESG
Since late February, the U.S. Securities and Exchange Commission has issued at least five public statements spelling out the wide variety of climate-related risks facing businesses and investors. It’s also warned the money-management industry about mislabeling ESG funds as being green when they really aren’t at all.
And last week’s confirmation of Gary Gensler, President Joe Biden’s appointee to lead the SEC, ratcheted up expectations that the agency will toughen oversight as compared with the previous administration. Gensler, who previously served as chairman of the Commodity Futures Trading Commission, indicated at a Senate hearing in March that he plans to stick with the same focus on ESG issues put in place by Allison Herren Lee, who had been serving as acting chair.
As we mark the 51st anniversary of Earth Day tomorrow, one of the world’s most influential financial regulators has accomplished a 180-degree turn in only a few short months. The SEC made plain its new direction on Feb. 26, when it issued a bulletin to educate investors about environmental, social and governance funds that laid out key questions consumers should ask before doling out any money.
Less than a week later, the regulator followed up with a statement from the Division of Examinations listing its top priorities. The first was climate-related risks.
Among other steps, the SEC plans to monitor “proxy voting policies and practices to ensure voting aligns with investors’ best interests and expectations, as well as a firm’s business continuity plans in light of intensifying physical risks” associated with climate change. “Through these and other efforts, we are integrating climate and ESG considerations into the agency’s broader regulatory framework,” Lee wrote.
A day later, on March 4, the SEC announced the creation of a climate and ESG task force within the Division of Enforcement to develop initiatives to proactively identify ESG-related misconduct. The initial focus will be to uncover any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.
Lee then wrote in a March 15 statement that she had asked staff to evaluate the SEC’s rules “with an eye toward facilitating the disclosure of consistent, comparable and reliable information.” Investor demand for specifics about “climate change risks, impacts and opportunities has grown dramatically” since 2010, she said.
“Climate and ESG are front and center for the the SEC,” Lee wrote. “We understand these issues are key to investors—and therefore key to our mission.”
On April 9, the commission’s Division of Examinations issued a “risk alert,” saying there’s a high likelihood that some investment advisers are promoting funds as ESG products when the reality is quite different. Certain mischaracterizations were so bad that the agency signaled firms— without naming any—may be violating securities laws.
The string of pronouncements makes clear the SEC is serious about stamping out the mis-selling of investment products and improving corporate disclosures. The onus is now on Gensler and his colleagues to follow through to ensure that investors are protected.
Covid Shock And Ark Effect To Spur $1 Trillion Boom In ESG ETFs
Citigroup strategists ramp up forecasts after investor inflows skyrocket.
As the global pandemic intensifies the boom in ethical investing, Citigroup Inc. now projects ESG stock ETFs in the U.S. alone will boast more than $1 trillion in assets by 2030.
Analysts at the bank reckon the global pandemic has stirred investor demand for companies doing good, especially those with strong labor practices. Add the frenzy for tech-focused thematic funds — many of which fall within the environmental, social and governance category — and the sustainability boom is smashing Wall Street projections.
“The past year’s Covid circumstance has accelerated equity ESG ETF adoption,” the team led by Scott Chronert wrote in a note. “Increased social awareness, and a growing interest in related structural themes, is causing us to rethink the appropriate roadmap for assessing the ESG ETF opportunity.”
A little over a year ago Citigroup expected $65 billion of assets in equity ESG exchange-traded funds by 2024 and $300 billion by the end of the decade. Both projections looked ambitious at the time. But the total is already at $112 billion, according to the U.S. bank.
The pandemic isn’t the only thing to draw attention to investments with a conscience. The Democratic control of U.S. Congress has triggered a rush into green funds as investors seek to front-run a potential wave of new environmental policies.
Another big reason for the accelerated growth is the increasing convergence between thematic and ESG categories. Thematic funds, which invest according to market niches like robotics or artificial intelligence, have been one of the past year’s hottest trends thanks to the high-profile success of firms like Ark Investment Management.
The categorization for certain funds is tricky and often comes down to a matter of labeling. But futuristic themes like genomics and cybersecurity are often considered ESG since they address social and governance concerns. A fund like BlackRock’s iShares Self-Driving EV and Tech ETF (IDRV), for instance, ticks both thematic and ESG boxes.
Chronert and team predict that ESG ETFs will account for 4.5% of total equity ETF market share by 2024 and 8.5% by 2030, which assumes about $4 billion per month of flows with zero market appreciation factored in. In the past year, monthly inflows have averaged closer to $5 billion, according to Citigroup.
These kind of bullish projections find support across the industry.
“It’s our view this next decade will all be about action and this action will be driven by what we’re observing everyday — the pandemic, climate change, social issues,” said Michael Arone, chief investment strategist for the U.S. SPDR exchange-traded fund business at State Street Global Advisors.
BlackRock At Odds With Warren Buffett’s Berkshire Hathaway Over ESG And Diversity Disclosures
Shareholder proposals highlight tensions between asset managers promoting ESG disclosures and executives who are pushing back.
The world’s largest asset manager is in disagreement with the world’s most famous investor.
BlackRock Inc. voted for two shareholder proposals that would require Warren Buffett’s Berkshire Hathaway Inc. to publish disclosures on how it manages climate risk and diversity efforts across its many businesses. Berkshire’s two shareholder-led proposals didn’t pass, but around a quarter of votes cast were in favor of the two proposals, Berkshire said during its annual meeting Saturday.
BlackRock’s vote highlights the growing tension between asset managers who are calling for companies to further emphasize ESG issues and executives who are pushing back. Mr. Buffett has defended the company’s current policies.
“The company is not adapting to a world where environmental, social, governance (ESG) considerations are becoming much more material to performance,” BlackRock wrote in a bulletin about its Berkshire decision.
The $9 trillion asset manager has already said it would wield votes it controls for investors more aggressively following criticism that it defers too often to company executives. In recent months it signaled it is more willing to support shareholder-led proposals on environmental, social and governance issues.
BlackRock isn’t alone in expressing discontent with Berkshire’s lack of disclosure. Institutional investors’ willingness to take on the company contrasts with the following of Mr. Buffett among his legions of fans—many of whom are professional investors themselves.
The results from Saturday mark “significant and growing disagreement” with the firm’s disclosures, said Meyer Shields, an analyst with Keefe, Bruyette & Woods.
Several large investors backed the demand for more disclosures. Federated Hermes, California Public Employees’ Retirement System and Caisse de dépôt et placement du Québec co-sponsored the proposal calling for climate risks reporting. Neuberger Berman supported that proposal and voted against some directors, arguing Berkshire’s board wasn’t sufficiently independent.
In addition to its votes on shareholder-led proposals, BlackRock also voted against the re-election of two Berkshire directors. It said Berkshire didn’t interact enough with institutional shareholders, didn’t have an adequate plan for addressing climate risks and lacked a lead independent board director.
Mr. Buffett has been critical of independent board members in the past.
Most recently, in his 2020 annual letter, Mr. Buffett said independent board members are paid hundreds of thousands of dollars for only a few days of work a year. He said they aren’t vested in the future of the company and too often side with whatever management wants.
“I feel better when directors of our portfolio companies have had the experience of purchasing shares with their savings, rather than simply having been the recipients of grants,” he wrote at the time.
Berkshire’s dual-share class structure leaves many shareholders with little voting power compared with company insiders. Mr. Buffett controls about a third of voting power at Berkshire.
So far, Berkshire executives have dismissed the votes by institutional investors.
“Overwhelmingly the people that bought Berkshire with their own money voted against those propositions,” Mr. Buffett said Saturday. “Most of the votes for it came from people who’ve never put a dime of their own money into Berkshire.”
He said making all the companies across Berkshire’s sprawling empire fill out a questionnaire because some outside organizations asked for it was “asinine.” It also went against the concept of autonomy the company was built on. The company has made clear to shareholders it recognizes that managing climate risks and a diverse workforce are important to the success of the firm.
Legions of individual investors who are devotees of Mr. Buffett traditionally vote in line with Berkshire’s recommendations.
For Berkshire, this army of individuals is a powerful ballast against professional investors. If this crucial base becomes less loyal once the 90-year-old Mr. Buffett gives up leadership of Berkshire, it could change the voting dynamics.
“I don’t think his successor will be given the same latitude to say, ‘We don’t want to do it, therefore we won’t do it,’ ” Mr. Shields said.
If fewer individual investors stick around with the stock when Mr. Buffett steps down, it will be harder for Berkshire to refuse the demands of professional investors, he added.
Berkshire has chosen Berkshire vice chairman Greg Abel to take over as chief executive when Mr. Buffett retires.
Some longtime Berkshire shareholders have reiterated their support for Berkshire, now that succession plans have become clearer.
“We couldn’t be more pleased,” said Berkshire shareholder Thomas Russo, managing partner of Gardner Russo & Quinn, of the decision to have Mr. Abel take over someday.
Some ESG Investors Turn To Emerging Markets, Defying Skeptics
There’s a growing number of money managers in green finance turning to markets not usually associated with sustainability.
Fund bosses in Europe’s North, where climate-friendly investing has gone mainstream, have started looking much further afield to find cheap assets they say will eventually meet their environmental, social and governance goals.
Nordea Bank Abp’s $450 billion asset management unit is among those trying out the strategy, and has just launched a fund targeting ESG assets in emerging markets.
“We felt it was a compelling idea,” said Thede Ruest, head of emerging debt markets at Nordea’s investment management unit in Copenhagen.
He expects the strategy to deliver “slightly better yield without too much risk-taking.” He also hopes it will “make a difference where it arguably will matter more.”
Nordea’s Global Green Bond Fund will invest at least 70% in green bonds, while the rest will be in conventional bonds issued by sustainable businesses, as well as social and so-called sustainability-linked debt. Of the total fund, about a fifth is currently allocated to emerging markets.
Money managers who have already spent time digging around for sustainable investments in emerging markets say ESG is definitely gaining a foothold, but from a rocky beginning.
“In the past, a great deal of companies didn’t even know what the acronym ESG stood for,” according to Burton Flynn and Ivan Nechunaev, fund managers at Terra Nova Capital, which advises the Evli Emerging Frontier fund. “When we would explain, many would push back saying that it’s all nonsense and some would outright laugh at us.”
The two recall a 2019 meeting in which a chief financial officer “stared at us blankly when we asked about their ESG policy.” After explaining what it is, “she burst into laughter.”
The head of a stock exchange in another frontier market “asked sarcastically, ‘do you guys really believe in wind energy?’”
But things have already changed and now, it’s “quite rare” to come across firms that are unaware of the demands being made by ESG investors, Flynn and Nechunaev said.
Ruest at Nordea says a major worry now is that some firms aren’t as clean as they claim.
“It’s a nightmare of mine that we should expose ourselves to greenwashing,” he said. “That is one of the biggest fears I have.” He says that fixed-income investors tend to enjoy more protections than others, but asset managers still need to come up with their own litmus test to avoid ESG fakes.
“What we always look for is to have credibility in the issuer, we want to see credible plans in the whole transition of the issuer,” Ruest said.
But there’s a school of thought that argues companies in emerging markets are actually less likely to be guilty of greenwashing than their developed-market peers.
That’s because they’ve been under less pressure to disclose ESG metrics, and aren’t used to having to pretend they’re more virtuous than they are, according to Karine Hirn, founding partner and chief sustainability officer at East Capital in Stockholm.
Frontier markets tend to provide “amazing” opportunities for ESG-focused active investors, Hirn said. She’s developed a grading system that measures a company’s expected transition toward a more sustainable business model to guide investment decisions.
Rather than going with established names she says, “You want to invest in companies that are improving in terms of ESG.”
Mattias Martinsson, chief investment officer at Tundra Fonder, says that “if you really want to do in-depth ESG analysis in these markets, you need to spend the time and do it on a company by company basis. The main challenge today is still transparency in these markets.”
Flynn and Nechunaev say ESG investors face increasingly crowded markets, in which sustainable assets fly off the shelf.
“Of course we like best-in-class ESG companies,” they said. “But we really love to invest in companies with opportunities for improvement.”
“Investing only in companies that have high ESG standards doesn’t fix problems,” they said.
And companies with “stellar ESG reputations” tend to be expensive, which could add to the risk of an “ESG bubble.”
Wall Street Taps Political A-Listers For $30 Trillion Green Boom
Hiring names to open doors comes as green rules are debated, with lobbying in focus and greenwashing risks growing.
Mark Carney to Brookfield Asset Management. Brexit architect Nigel Farage to DGB Group. A senior Obama aide to BlackRock Inc.
One after another, the high-profile hires came in recent months, and in each case, they were handed some iteration of the same mandate: To help their new employers safeguard and grow their burgeoning green-finance businesses.
The sudden rush to embrace political insiders is a powerful sign of just how far responsible investing has come from the eccentric fringes of finance.
While business has long been a path into politics and out again, joining a company that plants trees to offset emissions was once a risky career move.
Yet so much money — more than $30 trillion by some counts — is now tied up in green finance that the industry is successfully wooing an illustrious list of household names and policy wonks to keep lawmakers in London, Brussels and Washington on their side and the good times rolling. Other recruits include Chuka Umunna, Farage’s one-time arch Brexit opponent, and Luciana Berger, another former U.K. parliamentarian.
“They’re not hiring these politicians because of their expertise on finance and economics — they’re hiring them on their expertise on influencing policy, both their connections to people in government and knowledge of how to game the system,” said Simon Youel, head of policy at Positive Money, which campaigns to reform the banking system. “This revolving door is enabling big institutional investors and corporations a disproportionate impact over policy making.”
While angst over climate change helped build this cash cow, it’s politics that will determine whether the industry’s next decade sees it ossify or take in trillions more dollars. From the U.S. to China, governments are designing rubrics, drawing up standards and creating regulations to define what counts as “green,” reshaping the landscape for the banks and money managers that dominate this world, and unsurprisingly want to influence the outcome.
Bondholders are already wising up to signs that companies are exaggerating or misrepresenting their environmental chops when selling debt, a practice known as greenwashing. Questions are also multiplying around the impact of carbon credits, embraced by corporates to slash their environmental footprint. And the financial-services sector itself has been criticized for funding fossil-fuel producers. With mainstream banks now recruiting well-known faces to promote their brand of green finance, the industry’s feel-good veneer could crack.
“Because of the effectiveness of the green-finance agenda, it tends to have more supporters than critics,” said Adrienne Buller, a senior research fellow at the Common Wealth think tank, which focuses on building a sustainable economy and counts former U.K. Labour Party leader Ed Miliband among its directors. “There’s a few people calling out instances of greenwashing, but the response tends to be ‘we need to root out greenwashing so green finance can do its job’ rather than taking a critical look at green finance as a whole.”
ESG—as adhering to environmental, social and governance principles is known—is a ” gold rush” leading policy makers to accelerate companies’ disclosure requirements, said Adeline Diab, head of ESG for EMEA at Bloomberg Intelligence. So it’s in the interests of banks and asset managers to get a little political in their hiring, even with the heightened scrutiny applied to such relationships in the wake of former Prime Minister David Cameron’s lobbying for collapsed lender Greensill Capital.
While discerning the direct impact of this hiring spree on legislation is fraught with difficulties, the influence of finance and business over green policy is already making some queasy.
“We’re seeing a lot more sustainability legislation going into financial regulation today and of course some people are trying to wind that back so it’s not as strong,” said Fiona Reynolds, chief executive officer of the United Nations-backed investor group Principles for Responsible Investment. Change is still happening but “there has to be strong rules in place and transparency,” she said.
The European Union’s watchdog ruled in November that the European Commission failed to fully consider conflicts of interest when it appointed BlackRock to advise on new sustainable-finance requirements for banks. The firm’s segregation of its advisory arm from its investing unit wasn’t enough to prevent staff from being influenced by the general strategic interests of the company, an ombudsman wrote; BlackRock oversees billions of dollars in green funds as the world’s largest asset manager. The EC pointed to the technical quality of the firm’s pitch to support its choice.
And in the U.K., the government is preparing to issue the nation’s first sovereign green bond after a parliamentary push spearheaded by Gareth Davies, the former head of responsible investment at Columbia Threadneedle Investments who’s now a member of Parliament for the ruling Conservative Party. In 2019, the same year Davies was elected, Columbia Threadneedle wrote a letter urging the U.K. government to issue green gilts.
“You would expect the level of engagement to be high and I don’t think anyone should apologize for having ongoing discussions about that,” Davies said in an interview. “We recognize the power of the finance sector to solve some of the problems the government is trying to fix. It’s not because we’re trying to get more influence for the financial-services sector.”
Green finance’s highest-profile hire to date is Mark Carney, the former Bank of England governor and long-time advocate for sustainable investing. He joined Brookfield last year as head of ESG, with CEO Bruce Flatt saying at the time he would be instrumental in expanding the firm’s ESG group because of his strong relationships with sovereign wealth funds and his range of business experience.
Carney has since persuaded banks, including Morgan Stanley and Citigroup Inc., to sign a plan to cut emissions, and his work straddles the private and public sectors. He currently serves as U.K. Prime Minister Boris Johnson’s finance adviser for the COP26 meeting to be held in Glasgow in November, making him an important voice at the United Nations climate talks.
And on top of that, he’s a leader of the Taskforce on Scaling Voluntary Carbon Markets, an effort to set up a global trade in carbon offsets for the private sector.
A more unlikely convert is Nigel Farage, a skeptic on climate change when leader of the UK Independence Party, who recently joined a Dutch firm involved in carbon offsetting. His role is “to facilitate introductions to politicians and business leaders in the U.K. and around the world,” according to a company press release.
“From a PR point of view, he’s a headline machine,” said Selwyn Duijvestijn, chief executive of DGB Group, Farage’s new firm. “Texas oil workers, they don’t listen to Greta Thunberg, but they do need to become aware that we need to do something,” he said in an interview, referring to the teenaged climate activist. “They would rather listen to Nigel Farage than Greta Thunberg.”
On the other side of the political spectrum, Chuka Umunna, Farage’s one-time sparring partner during the U.K.’s prolonged withdrawal from the EU, became JPMorgan Chase & Co.’s head of ESG for EMEA earlier this year. Umunna arrived after a short stint co-heading Edelman’s ESG consultancy following almost a decade in Parliament.
A bank memo at the time said he would help clients “successfully navigate the evolving ESG landscape.” Meanwhile, Umunna’s former colleague Luciana Berger is the incoming chair of used-car seller Cazoo’s ESG committee. Cazoo declined to comment beyond an earlier statement.
It’s not just a European phenomenon. BlackRock recently replaced one departing White House insider with another. Paul Bodnar, an Obama-era climate-policy aide, is now the firm’s sustainable investing head, taking over from Brian Deese, who returned to politics as President Joe Biden’s National Economic Council chair. The firm has hired more than a dozen alumni from the Obama administration over the years.
Where once it was electorally advantageous to take a tough line against bankers, such as in the wake of the 2008 financial crisis, the finance industry has worked hard to rebrand itself as an agent of change, crucial in the transition to a lower carbon economy. That’s made it easier for politicians, particularly those with more progressive or center-left positions, to join their ranks.
There will be no shortage of opportunities in years to come. ESG assets are on track to almost double to $53 trillion by 2025, according to Bloomberg Intelligence. And while banks still earn more from lending to fossil-fuel companies than marketing sustainable bonds, going green has other benefits, not least sating the activist shareholders, regulators and tax collectors pressuring the finance industry to clean up its act.
“When policy makers leave for big banks or other investment institutions to take care of ESG, that’s very welcome to the financial sector,” said Kenneth Haar, a researcher at the Corporate Europe Observatory, a Brussels-based public-interest group. “More than anything they need to be seen as institutions which take climate change seriously, and they need a friendly face to sell that idea.”
EU Recovery Plans Have Lawmakers Worried About Greenwashing
The Greens in the European Parliament warned that some member states’ recovery plans may lead to so-called greenwashing and could fail to meet the region’s climate-related spending goals as it embarks on an unprecedented energy transition.
The political group called on the European Commission to reject national measures that are not in line with standards set for a climate-friendly recovery.
While some national plans appear to meet climate-related spending targets on paper, “a closer look reveals that billions of euros are subject to mis-tagging and rulebending,” it said in a letter to the European Union’s executive.
The 27-nation EU wants to become the world’s first carbon-neutral region by 2050, an effort known as the Green Deal. It is a central pillar of the EU’s Next Generation plan — a 800 billion euro ($974 billion) pandemic-recovery fund — as well as its next seven-year budget.
The legislation associated with the fund sets “ambitious goals in making the EU recovery plan an instrument of its green and digital transformation,” Philippe Lamberts, president of the Greens in the parliament, said in a statement. “Letting it become just another greenwashing exercise will gravely harm the very credibility of the EU Green Deal.”
To ensure that the massive stimulus helps advance the ambitious clean-energy overhaul, the EU agreed that at least 37% of each national plan must be allocated for climate-related investments. In addition, member states must respect the “no harm” environmental principle, which aims to channel spending into technologies that are in line with Green Deal objectives.
According to the letter to the commission, the Greens have identified “many cases” where EU requirements and the classification of green investments have been “circumvented, ignored or simply not addressed — leading to greenwashing and in some cases to a potential breach of the 37% spending requirement for green investment.”
Below Are Some Of The Shortcomings In Member States’ Recovery Programs Cited By The Greens In The Letter:
* Allocation of significant amounts of funding to hybrid vehicles in Germany, France and the Czech Republic even if such investments aren’t compliant with EU climate goals
* Lack of detail and regulatory requirements for building renovations in Italy, Portugal and the Czech Republic
* Erroneous classification of low-emission public transport in Slovenia and Poland
* Authorization of purchases of diesel-fueled tractors under a measure to modernize the agriculture sector in Italy
* Dubious classification of instruments to support entrepreneurship in the Czech Republic
* Replacement of coal-based heating systems with gas boilers being labeled as fully contributing to the green target
More than 20 EU member states have so far submitted their national plans. The commission has two months to assess them.
Europe’s ‘Green’ Disclosure Rules Give Fund Investors Clarity—and Confusion
The regulations are designed to bring order to ESG investing. But they leave a lot of room for interpretation.
The European Union’s new anti-greenwashing regulation is making asset managers assess how “green” their funds really are in terms of helping society and the environment.
Known as the Sustainable Finance Disclosure Regulation, or SFDR, the rules aim to prevent fund firms from exaggerating sustainability claims to make their products seem more attractive and to provide more clarity to investors who want to put their dollars behind certain causes.
Under the first phase of the regulation, which took effect March 10, asset managers had to start disclosing information on their funds if they promote certain environmental or social causes or objectives. Starting in January 2022, managers will have to back up green-fund claims with more detailed disclosure, such as the policies they use to evaluate companies’ governance practices.
While many fund firms say they welcome the efforts to bring order to the ESG investing space, they also say the rules leave plenty of room for interpretation on what exactly constitutes a green fund. In addition, regulators are still discussing what kinds of disclosures will be required come January.
“One of the challenges is the fact that asset managers classify funds themselves,” says Elodie Laugel, chief responsible investment officer at French fund firm Amundi, which manages 1.755 trillion euros (US$2.093 trillion) of assets overall. This naturally leads to differences in practices and approaches, the firm says.
Transparency, Not Labels
Under the EU regulation, asset managers are obliged to put their funds into one of three categories: A so-called Article 6 fund has no clear environmental, social or governance factors or objectives. An Article 8 fund (commonly referred to as light green) is broadly defined as one that furthers an environmental or social aim in some way—for example, it promotes gender equality on company boards.
An Article 9 fund (or dark green) must have sustainability as its sole objective and ensure the companies it invests in cause no significant environmental or social harm under the definition of sustainability that the EU has set out in the SFDR. A light-green fund could, in theory, invest in both a plastic-recycling business and a tobacco grower, whereas a dark-green fund can’t invest in anything that would cause significant social or environmental harm.
The categories might seem simple, but classifying funds under the EU’s framework isn’t a tick-the-box exercise. That is especially true for the light-green category, where the parameters of what constitutes a “promotion of an environmental or social characteristic” aren’t specifically defined.
“When a financial product promotes an environmental or social characteristic, [asset managers] have to disclose the appropriate information required by the SFDR. There is no separate definition or description of what ‘promotion of environmental or social characteristics’ is,” says Patrik Karlsson, senior policy officer at European Securities and Markets Authority, which codesigned the regulatory technical standards.
As a result, a light-green fund at one company can look very different from a light-green fund at another company, with one simply screening out harmful investments and the other much more actively promoting a particular ESG aim.
While that could make it hard for investors to make apples-to-apples comparisons of funds across companies, the regulation’s supporters don’t see a problem, saying the rules are designed to promote accountability, not specific labels. The disclosures, they say, will reveal a manager’s approach to sustainability, providing an element of transparency in a field where a lack of accountability has been a major obstacle due to the lack of global standards around ESG data and regulations.
That’s what we want,” says Wolfgang Kuhn, director of financial sector strategies at ShareAction, a nonprofit that promotes sustainable investing. “We want fund managers to nail their colors to the mast and say: ‘This is sustainability for us.’ Then as the client you can hopefully better decide whether that works for you or not.”
The critical element for asset managers is to articulate to clients what they’re doing, how they’re doing it and how sustainability is integrated into the fund portfolio, says Navindu Katugampola, global head of sustainability for Morgan Stanley Investment Management. “SFDR is a disclosure regulation, not a sustainability label,” he says.
In the first quarter of this year, European sustainable funds had 120 billion euros of inflows, according to data from Morningstar Inc. That was more than half of all the new money flowing into funds in Europe and an 18% increase from the fourth quarter. Excluding money-market funds, funds of funds, and feeder funds, Morningstar estimates that a combined 2.38 trillion euros in assets had been classified as Articles 8 and 9 as of the end of May.
“There’s a lot at stake with SFDR. Many asset managers don’t want to be left behind or be seen as not trying to ‘promote environmental and/or social characteristics,’ ” says Hortense Bioy, global director of sustainability research at Morningstar.
BNP says its high proportion of green funds is the result of its long record of incorporating ESG into its investing strategy rather than a more relaxed interpretation of the regulations. The firm points to binding targets it set more than two years ago—before SFDR—that tie a fund’s performance to factors such as reduced carbon footprints. Even the funds that don’t fall into Article 8 or 9 categories take sustainability risk into account, BNP says.
Fund managers with green-classified funds will have to make periodic disclosures under the EU rules, showing how successful the product has been in meeting its stated “green” characteristic or objective. Supervision and enforcement of the rules will fall to regulators in each country, known as national competent authorities, since the SFDR itself doesn’t have an enforcement chapter, adding another layer of interpretation to the mix.
“As with most EU legislation, national competent authorities (NCAs) will always have slightly different approaches in terms of how they enforce the rules,” says Maria Van Der Heide, who heads up EU Policy at ShareAction.
The European Fund and Asset Management Association, a trade group that has been outspoken in voicing concerns about the rules, says that under an “all-embracing” interpretation of what it means to promote social or environmental good, too many funds would be allowed to fall under Article 8.
A fund that’s simply complying with national laws such as not investing in cluster munitions, for example, could be marketed as Article 8, potentially misleading clients and undermining one of the SFDR’s overarching goal: to stop greenwashing.
The association, which remains supportive of the SFDR’s overall framework, says its members prefer to identify products as Article 8 only when their environmental and social characteristics are binding for investment decision-making and thereby offer a clear environmental and social value proposition.
Asset managers also say that collecting the data needed to back up green-fund claims will be challenging.
Norwegian financial-services firm Storebrand AS, which says 69% of the assets it manages are in Article 8 or 9 funds, says the industry as a whole is struggling to get sustainability data from companies that is good and consistent.
“This is challenging in terms of documentation, and may to some extent encourage different degrees of ‘creativity’ in their products and SFDR compliance,” says Bård Bringedal, the firm’s chief investment officer. Still, he says the teething problems are a necessary—if painful—step.
Other asset managers with ample offerings of Article 8 or 9 funds agree. Maria Lombardo, who heads up European ESG client strategies at Atlanta-based Invesco Ltd. , says that “we don’t talk about it, but we need this rigor now to incorporate [ESG].”
Invesco aims to integrate ESG into all its assets by 2023.
Oil Lobbies Attack The SEC Over Mandatory ESG Disclosure
Fossil fuel companies say the voluntary system of revealing financial risk is more than enough for shareholders.
When it comes to being upfront with shareholders about the risk climate change poses to its survival, the oil industry—whose products are the key driver of global warming—is deeply divided.
On one side, there are industry trade groups like Western Energy Alliance, which insist on denying the science of global warming (and certainly won’t concede its members’ role in it). On the other, there are Big Oil companies like Chevron Corp., which contend they are open to providing more information about how the climate crisis is affecting their bottom line.
These contrasting positions have been made plain in comment letters sent to the U.S. Securities and Exchange Commission.
The regulator is soliciting feedback as it considers rules mandating what companies must make public regarding the financial risk of environmental, social and governance compliance.
In a world that is moving steadily away from fossil fuels, it’s safe to say the risks faced by Big Oil are great.
Possibly the most aggressive memo was sent by the Western Energy Alliance, in conjunction with the U.S. Oil and Gas Association (USOGA), another industry trade group, according to researchers at Documented, which reviewed more than 580 submissions sent to the SEC.
In it, these oil-funded organizations assailed the SEC and its effort to impose ESG reporting requirements, and even questioned “the extent of anthropogenic contributions” on the environment, despite the settled scientific consensus that burning fossil fuels is the main cause of accelerating, catastrophic climate change.
Their position was broadly supported by right-wing organizations including the American Enterprise Institute, the Cato Institute and the Heritage Foundation.
What the SEC is pursuing would expand “its regulatory authority beyond investor protection and capital formation,” executives from the two oil trade groups claimed in their June 11 letter. “Implementing a comprehensive ESG disclosure framework would be yet another step into redefining the mission of the commission without congressional authority.”
The National Mining Association struck a slightly more modulated tone. While the coal industry trade group doesn’t question established climate science, it mainly opposes the enactment of new rules.
“The SEC shouldn’t create a one-size-fits-all, prescriptive, rules-based mandatory disclosure program given the breadth and scope of information already provided on a voluntary basis,” the NMA wrote in its 12-page letter.
SEC Commissioners Testify Before The House Financial Services Committee
In March, the SEC, then led by interim Chair Allison Herren Lee, signaled that companies may soon have to start disclosing more to shareholders about how climate change affects their business. The agency, now run by Gary Gensler, is currently working on a set of regulations that would do just that.
The SEC may unveil its proposals before the end of the year. The plan would then be subject to another round of public comments before a vote by commissioners to finalize the new requirements.
Groups like the NMA contend that the current system of voluntary reporting “adequately informs investors of known material risks and opportunities” and nothing more is needed.
Chevron, which like most fossil-fuel producers is under pressure from investors to reduce emissions, wrote in its letter to the SEC that it backs efforts by the agency “to enhance the consistency and comparability of climate information in public disclosures.”
The second-largest U.S. oil company added that it “strongly encourages the commission to consider a phased approach to any new sustainability-related disclosures. This would allow the commission to focus first on those topics it deems of most importance, such as climate change disclosures,” and then it could “revisit other sustainability-related topics.”
Unlike the oil trade groups, Chevron said it stands ready to offer “assistance as the commission moves forward with climate change disclosure initiatives.” By contrast, the letter from Western Energy and USOGA questions the regulator’s sincerity: Is the SEC planning to “expand its authority as to entirely upend the normal regulation and functioning of the financial system?”
Let Employees Take The Lead On ESG
That way, companies can improve both their ESG performance and their ability to attract and retain talent.
Companies that don’t give rank-and-file workers a central role in their environmental, social and governance (ESG) work are making a mistake. They risk alienating values-oriented employees who question company practices, and they miss a big opportunity for employee engagement at a time when attracting and retaining talent is imperative and difficult.
Active employee participation and leadership on sustainability issues not only improves ESG performance, it can help lure burned-out professionals back to the job, including those who have lost their motivation and are thinking about quitting, if they haven’t already. That can be a win for the company and its bottom line.
Control over the conditions of work, including whether an employer is living up to people’s values, has long been associated with employee commitment, satisfaction and health.
The pandemic has merely underlined the strong desire for employee choice about where and when to work, with those who care strongly quitting rather than returning to jobs that don’t inspire them. For many of them, money isn’t the issue. Talented young professionals, especially, want their work to align with their values.
This can be seen in the rise in employee activism. Employees might not join unions, but they stage demonstrations, start movements, post their preferences on social media and petition for change in business practices.
Over the past two years, employees at tech companies have protested the hiring and firing of certain executives, while workers at other companies have staged walkouts to protest sales to customers they believe are violating ethical practices.
Effective or not, these protests reflect the mood of the times: Employees increasingly are speaking out to hold employers accountable. They also are willing to put in personal time and energy to volunteer for causes they care about.
On global surveys, the rising generations express great interest in solving major problems such as climate change, poverty and other inequities and disparities. They collect money, serve on community boards and volunteer when they can. They even sign up for spouses’ causes.
When employees have opportunities to act on their favorite causes at work, innovation can rise from the ranks, elevating ESG performance. At an investment bank, a recent first-generation Latina college grad organized dozens of bankers to form an employee resource group and serve as recruiters and mentors for diverse talent.
At a beverage company, employees passionate about the environment proposed a roof garden to grow vegetables at corporate headquarters. At Procter & Gamble, metrics tied to the company’s purpose and values regularly inspire employees to innovate. Associates in West Africa’s diaper division, for example, created mobile health clinics for underserved infants; others mounted a campaign to help girls stay in school.
Cities regularly offer a portion of their budgets for “participatory budgeting,” in which community members can bid for budgets for projects to improve education, services or the environment.
Why not bring this practice into the corporate mainstream? IBM, for example, has initiatives within its IBM Volunteers program where employees can pick their individual causes, log volunteer time and earn a cash grant to their nonprofit of choice for hours volunteered.
Democratizing ESG activity is both proactive and protective. Legions of employees who care, and feel that their employers care about the same things, can bring enormous energy to help companies excel, especially given the link between ESG and long-term financial performance.
It’s a great way to channel activism into action for positive change, and to develop problem-solving leaders of the future, while giving them another good reason to return to the post-pandemic workplace.
Corporate Climate Efforts Lack Impact, Say Former Sustainability Executives
They’re speaking out, pushing for more aggressive government policies to address societal problems.
Tariq Fancy’s growing sense of unease and frustration with sustainable investing culminated on a private jet.
The irony wasn’t lost on Fancy, BlackRock Inc.’s former chief investment officer for sustainable investing. He was traveling in Europe in March 2019 when he had a heated exchange with a sales colleague. Fancy and his team had just presented the money manager’s latest low-carbon funds to prospective clients, when one asked what impact those funds had on actually cutting emissions.
Battling his own growing doubts on whether they had any effect, Fancy said that if enough of the funds were sold, it would create price signals that would eventually boost costs for high-carbon emitters. That would then prompt those companies to take action on cutting their carbon footprints, he said.
While flying to another meeting, Fancy said the salesman rebuked him for going off script. The salesman, Fancy said, told him that he should have stuck to the talking points by simply saying the funds are a way for clients to contribute to the fight against climate change, even though there wasn’t an explanation of how.
“It angered me,” Fancy said. “It’s disrespectful to give an evasive answer to a client. I realized that there wasn’t a lot of investment value, it just seemed to be entirely around marketing.”
It was yet another episode where Fancy found himself at odds with colleagues more focused on marketing sustainable funds—part of a trend he’s since dubbed “sustaina-babble”—rather than creating investments that have actual climate impact, he said. The rift is one of the things that prompted Fancy to quit a few days later.
Inside the booming world of sustainability, a small but growing cohort of disillusioned veterans are speaking out against efforts by corporations and investors to address an overheating planet, income inequality and other big societal problems. Environmental degradation has worsened, while the gap between the rich and poor has widened.
The overemphasis on measuring and reporting sustainability has delayed, and displaced, the urgent action needed to tackle those challenges, they say. Environmental, social and governance investing, or “ESGlalaland,” suffers from “cognitive dissonance,” sustainability veteran Ralph Thurm said in a March report titled “The Big Sustainability Illusion.” ESG ratings only explain “who is best in class of those that say that they became less bad,” he said.
“The bigger problem than greenwash is greenwish,” Duncan Austin, a former partner at Al Gore’s Generation Investment Management, said, referring to greenwashing where environmental benefits are exaggerated or misrepresented. “The win-win belief at the heart of ESG has led to widespread wishful thinking that we’re making more progress on sustainability than we really are.”
Corporations around the world have been clamoring to green their businesses. Hundreds have announced net-zero emissions targets and poured billions of dollars into solar and wind projects, while chief sustainability officers have become ubiquitous in C-suites.
In April, Amazon.com Inc. signed deals to add more than 1.5 gigawatts of power to its green energy efforts. Last month, Rolls-Royce Holdings Plc said it will make some plane engines compatible with using sustainable fuels, while Tyson Foods Inc., America’s biggest meat company, pledged to go carbon neutral by 2050.
The veterans acknowledge they were complicit and benefited from the boom in sustainability that got underway in the 1990s. And much good was created along the way, they say. But now they’re coalescing under one message: More aggressive government policies are needed to address the planet’s problems.
“The 20-year focus on corporate social responsibility reporting and the current frenzy on ESG investing have created an impression that more is happening to address social and environmental challenges than is really happening,” said Ken Pucker, a former chief operating officer at Timberland who had worked on the company’s sustainability projects. “Markets alone aren’t sufficient to solve these problems.”
Just months into starting his job at BlackRock in January 2018, alarm bells started going off in Fancy’s head. During one hours-long internal meeting to discuss ESG funds with senior management in London, the former distressed-debt investor said he sat silently as they solely focused on how to market them, rather than discuss their underlying investments.
In one client presentation, Fancy said he was taken aback when a BlackRock executive said that they didn’t want to see a politician fixing climate change and other big societal issues.
“I thought to myself, that’s exactly who should be solving the problem!” Fancy said. “A carbon tax will actually have an impact rather than the voluntary allocation of capital to ESG products.”
Whether investors are waging proxy fights against oil companies or divesting shares of high-carbon emitters, Fancy said such efforts aren’t enough to move the needle. Low carbon funds, for instance, are merely buying and selling shares of companies in the secondary market, and so have little impact on the companies themselves. If anything, private, long-term funds that invest in clean technologies are more likely to address climate change, he said.
“I’m clearly seeing inside the machine, and the market isn’t going to self-correct if there’s a market failure,” Fancy said. “Only regulation is going to solve that.”
Sustainable Investment Boom
Annual Flows Into ESG And Sustainability-Themed Exchange Traded Products
Since Fancy left BlackRock in 2019, the $9 trillion asset manager has stepped up its sustainability efforts. In January 2020, Chief Executive Officer Larry Fink said BlackRock would put sustainability at the center of its investments. Since then, the company has, among other things, said it may vote against corporate directors who fail to create plans to transition to a low-carbon economy.
BlackRock, which is based in New York, said it believes greenwashing poses a risk to investors and could be detrimental to the asset management industry’s credibility. That’s “why we strongly support regulatory initiatives to set consistent standards and increase transparency for sustainable portfolios,” the company said in a statement.
Consistent reporting standards for companies will enable investors to access material public information, which will help them make more informed decisions about achieving long-term returns as the world transitions towards net-zero emissions, it added.
After quitting BlackRock, Fancy is using an education nonprofit he founded to create short online courses to explain to a younger generation how the economy works and how to effect societal change.
Pucker, who now teaches sustainability at Tufts University’s Fletcher School, said he was an advocate of measuring and reporting business’s environmental and social impacts because he thought it would result in consumers and investors putting pressure on companies to behave differently. Over time, he started feeling differently.
“If they’re given information about water intensity or carbon emissions or diversity data, that’s all fine input, but it’s not going to radically change behavior in most cases,” he said. Even if those metrics were mandatory, audited and easy to compare, “a shift in mindset is needed,” he said. “We have to recognize that we are citizens, not just consumers.”
In hindsight, Pucker said he focused too much on reporting impacts, rather than actually improving them. While he said Timberland had succeeded in reducing emissions, it was only from its operations and not from its supply chains.
Those emissions, known as Scope 3, often make up the larger part of a company’s carbon footprint, and measuring them can be more challenging because of a lack of data and transparency. Pucker said Timberland and other companies could have worked together to develop a system to measure those emissions to use with their suppliers. “With our leverage, we could have made a difference,” he said.
One of the earliest cases of sustainability reporting was in India in the late 1970s, when the chairman of Tata Iron & Steel Co. asked its audit committee to report on whether it had met its social obligations. It wasn’t until the 1990s, though, when corporate social responsibility efforts really got underway.
Since then, 80% of companies globally report on things like water usage and their local community efforts as of last year, compared with 12% in 1993, accounting firm KPMG said in a recent report. In the U.S., assets in sustainable investing hit $17.1 trillion at the start of last year, up from $639 billion in 1995, according to industry group, the US SIF Foundation.
In 1994, John Elkington, a pioneer of corporate sustainability, coined the term “triple bottom line,” which meant that as well as profits, companies should also consider impacts on people and the planet. But just like how companies recall products when problems arise, Elkington in 2018 called for a recall of the phrase.
Elkington said that while he’s proud of how the term took root, it has some dysfunctions. He said he would get “extremely nervous” when management teams would too often say they had made profits and met social goals by providing jobs, but then report that they hadn’t made environmental strides.
“The original proposal was to offer progress on all three bottom lines, not a tradeoff where you’re sacrificing one in favor of the others,” Elkington said in an interview. Corporations instead need to have an “expanded single bottom line,” where social impacts are quantified and included in profit and loss calculations, he said.
Auden Schendler had extolled the virtues of corporate sustainability, only to spend decades taking aim at the movement. As head of sustainability at Aspen Skiing Co. in Colorado, Schendler admits to his blunders. He said he had bought renewable energy certificates only to conclude they were “meaningless paper transactions that didn’t move the needle on clean energy.”
Schendler once switched the ski resort’s snow vehicles to biodiesel, but then had to reverse course after the fuel caused microbes to grow and clog the tanks, he said. One of Aspen Skiing’s wins, however, was a project to convert waste methane from a coal plant into electricity, cutting methane emissions.
Over the course of his career, Schendler’s arguments against corporate sustainability have evolved from the movement being insufficient, to being a distraction, to being a dodge in addressing the planet’s problems. And then in March, during a lunchtime bike ride weaving through the Colorado mountains, Schendler came to another realization: Corporate sustainability is complicit with the fossil fuel industry.
“I thought, what would fossil fuel companies want other businesses to be doing?” Schendler said. “The answer is all this sustainability.” It doesn’t threaten high carbon-emitters nor interfere with their business models, there’s no intervention in policy and no public shaming, he said. “That’s when the word complicity came into my head.”
For the most part, corporate sustainability ends up being small, non-systemic changes, Schendler said. Companies should be spending much more money on climate lobbying, he said. “They need to use their power and voice much more aggressively in the political process.”
After posting quotes in ski lifts from Pope Francis about global warming, Schendler has been working on installing kiosks in the ski resort’s lobbies where guests can use pre-paid postcards to write to senators urging them to take action on climate change.
Al Gore Warns Greenwashing May Stop The Climate Fight In Its Tracks
“There remains a yawning gap between long-term climate goals and near-term action plans,” the former U.S. vice president says.
Al Gore warned that the “the mounting threat of greenwash” poses a significant and increasing risk to a successful transition away from fossil fuels.
“There remains a yawning gap between long-term climate goals and near-term action plans” at both the corporate and government levels, the former U.S. vice president said, adding that the chasm encompasses more than just environmental issues. “Large emitters must increase their climate ambitions with renewed credibility and urgency. Likewise, developing countries urgently need substantial support on vaccine access, climate finance and debt relief.”
At the same time, sustainable investing has “entered the mainstream,” providing even more openings for potential greenwashing, said Gore, 73, currently chairman of Generation Investment Management. “We must be vigilant about the rising threat of greenwashing or risk derailing hard-won progress” that has been made in recognizing the climate crisis, he said.
Generation Investment has just published its fifth annual assessment about the transition to a sustainable economy.
It cites data from national consumer protection authorities, which estimate that 42% of environmental claims have been “exaggerated, false or deceptive,” and might even violate fair practice rules established by the European Union. Separately, Gore’s firm said data from Climate Action 100+ show that about 53% of the 159 companies it tracks—which includes the world’s largest emitters of greenhouse gases—don’t have appropriate short-term targets for net-zero emissions.
The Generation Investment report draws on more than 200 sources to highlight key tipping points in the shift to sustainability—from the widespread adoption of net zero to action on diversity, equity and inclusion, and the rise of clean technologies and natural solutions.
First, The Good News From The Report:
* Sustainability-related fund flows from the financial industry tripled over the past five years, with more than 6% of global market capitalization volumes now projected to come from the green economy, up from 2% in 2015.
* Since 2015, the market has seen a 10-fold gain in new investments in environmental, social and governance funds.
* During the same period, there’s been an eight-fold increase in sustainable debt issuance, and a doubling of private equity and venture capital deal flow in the areas of sustainability.
* Today, governments that represent three quarters of global gross domestic product have made national-level commitments to net zero.
Second, The Bad News:
* Many governments and companies remain lacking when it comes to setting interim net-zero pledges and short-term action plans.
* More than half of the world’s GDP—some $44 trillion of economic value—is at moderate or severe risk due to nature loss.
* There’s growing unease about the low quality of some net zero commitments because of the gap between goals and actions, and the absence of guardrails for those using natural solutions such as offsets to meet climate pledges.
* Consumers are often faced with confusing and misleading claims about the benefits of sustainability.
To be sure, the past year has presented huge opportunities for sustainable investing, as the enormous flows of capital to green bonds and renewable energy attest. But a failure to tackle greenwashing is hobbling the transition to a low-carbon economy, Gore said. “The time for celebrating vague, distant goals on net zero has long passed,” he said, adding that “investors now need clarity over how companies will turn goals into actions.”
For example, about half of the Fortune 100 companies mention biodiversity in their reports, but only five have made specific, measurable and time-bound commitments on biodiversity, according to Generation’s research.
Large increases in “the deployment of sustainability solutions” are needed to limit global temperatures to 1.5 degrees Celsius above pre-industrial temperatures, Gore said. For the environment, this means deployment rates must increase by five to 10 times over the next few years for technologies like electric vehicles, solar, hydrogen and wind power, as well as carbon capture and storage.
Sustainable investors “will do more harm than good if we fail to set a high bar,” Gore said.
Don’t Throw Out The Baby With The Greenwashing
Regulators are investigating DWS’s ESG practices. While the risks of misrepresentation are real, they shouldn’t hobble efforts to allocate capital with virtue in mind.
News that regulators are investigating DWS Group GmbH for allegedly greenwashing some of its funds highlights an uncomfortable truth about environmental, social and governance labeling: It’s impossible to agree what qualifies as an acceptable investment. But the more effort that’s made, the better the outcomes will be, even if they fall short of perfection.
The Securities and Exchange Commission is probing whether DWS, a Frankfurt-based asset manager that’s 80% owned by Deutsche Bank AG, overstated its application of ESG criteria to some investment products, according to the Wall Street Journal. The German financial regulator BaFin is also scrutinizing the firm, Bloomberg News reported Thursday.
The investigations come after the Journal said earlier this month that Desiree Fixler, who was fired as the firm’s chief sustainability officer in March, filed an unfair dismissal case alleging she was dismissed for objecting to ESG claims made in the company’s annual report.
Fixler is not the first former ESG fund chief to accuse an employer of greenwashing. Tariq Fancy, the former chief investment officer for sustainable investing at BlackRock Inc., the world’s biggest asset manager overseeing $9.5 trillion, in March said the industry offers nothing more than “marketing hype, PR spin and disingenuous promises” in marketing funds that claimed to be ESG friendly.
As clients increasingly demand that their money doesn’t contribute to activities that harm the environment or promote injustice, the pressure to compete in offering such investment strategies is relentless and growing. Bloomberg Intelligence estimates the total global market for ESG investment products will surpass $50 trillion in the next five years — a bandwagon no fund management firm can afford to miss.
DWS has capitalized on the trend. Some 4 billion euros ($4.7 billion) of the 19.7 billion euros of net inflows it attracted in the second quarter of this year came into dedicated ESG funds. In 2020, a third of DWS’s 30 billion euros of new money was for ESG products. The double-digit percentage fall in the company’s stock price in European morning trading on Thursday highlights shareholders’ concern that regulators will find fault with the firm’s ESG practices.
Investors are acutely aware of the dangers of being misled by marketing. A survey published in May by London-based wealth manager Quilter Plc, which oversees 127 billion pounds ($175 billion), showed that greenwashing was the biggest concern when it comes to investing responsibly among 1,500 investors with at least 60,000 pounds in investible assets. It beat even worries about higher fees and underperformance.
Fancy, the former BlackRock executive, has followed up his earlier diatribe with an article earlier this month that said so-called sustainable investing is “a dangerous placebo.” Only government action, he argues, can solve the climate emergency.
He’s probably correct that only nations have the firepower to remedy the various ills spoiling the planet. But that doesn’t mean the fund management industry can’t do its bit to influence the companies they invest in to be less harmful in their activities.
Fancy’s former employer, for example, voted against 255 board directors for failing to act on climate issues in the proxy period ended June 30, a fivefold increase in the shareholder’s activism compared with a year earlier. And BlackRock backed tiny fund management firm Engine No. 1 earlier this year in its successful effort to place three dissident directors on the board of Exxon Mobil Corp. to press for more climate action from the energy company.
As the primary allocators of capital, asset management firms have been pushed somewhat reluctantly to the forefront of the climate fight. But at least they’re belatedly rising to the challenge of actively seeking change in return for the money they invest. It would be a shame if overzealous regulators became a deterrent to those efforts. The perfect shouldn’t be allowed to become the enemy of the good.
Regulators Intensify ESG Scrutiny As Greenwashing Explodes
Pressure is increasing on fund managers to show they’re being truthful with customers about what they’re selling.
Pressure is increasing on managers of ESG-labeled investment funds to show they’re being truthful with customers about what they’re selling.
The heat was really turned up last week when the U.S. Securities and Exchange Commission and BaFin, Germany’s financial regulator, initiated a probe into allegations that Deutsche Bank AG’s DWS Group asset-management arm has been misstating the environmental—and possibly the social—credentials of some of its ESG-labeled investment products. Regulators have signaled the review is at an early stage, and DWS has rejected claims it overstated ESG assets.
Since then, researchers have raised questions about the credentials of money managers who claim they are marketing funds designed to address the climate crisis and social injustice.
A London-based nonprofit called InfluenceMap said more than half of climate-themed funds are failing to live up to the goals of the Paris Agreement. Christiana Figueres, former executive secretary of the United Nations Framework Convention on Climate Change, said the world’s sovereign wealth funds will be on the wrong side of history if they cling to strategies that don’t acknowledge how rapidly the planet is warming.
Figueres didn’t accuse wealth funds of greenwashing, but she bemoaned what she said was the industry’s failure to embrace strategies that commit to a lower carbon footprint.
The timing of these comments is troubling for an industry that has ballooned to $35 trillion of assets, with many money managers betting that investors will keep pouring more money into funds marketed as adhering to the best environmental, social and governance principles.
Marketed being the key word. The reality, however, is quite different. InfluenceMap found that 55% of funds marketed as low carbon, fossil-fuel free and green energy exaggerated their environmental claims, and more than 70% of funds promising ESG goals fell short of their targets.
“As the number of ESG and climate-themed funds has exploded in recent years, so too have concerns among investors and regulators about greenwashing and transparency,” said Daan Van Acker, an analyst at InfluenceMap.
The SEC formed a task force in March aimed at investigating potential misconduct related to companies’ sustainability claims. Gary Gensler, who took over the agency in April, has said his staff is working on a rule to boost climate disclosures by stock issuers, and that the regulator remains focused on ESG issues.
In a recent report, the Global Sustainable Investment Alliance erased $2 trillion from the European market for sustainable investments after anti-greenwashing rules were introduced in March by the European Union.
The Sustainable Finance Disclosure Regulation, or SFDR, demands that fund managers evaluate and disclose the ESG features of their financial products. For ESG, there are now “light green” Article 8 funds, which are defined as those that actively promote environmental or social characteristics, and “dark green” Article 9 funds, which have sustainable investment as their main objective. Both groupings are subject to higher standards of disclosure under the SFDR.
There aren’t yet similar requirements in the U.S., so it’s uncertain how many true-green ESG funds there really are. At the end of 2020, sustainable assets totaled about $12 trillion (after GSIA’s decision) in Europe, compared with closer to $17 trillion in the U.S.
Given the shrinkage in Europe, the U.S. figure may see a similar reduction when more regulatory rigor is brought to bear.
SEC Takes A Different Route Than Europe On Climate Disclosures
U.S. regulators seem to have chosen a company-focused approach when it comes to climate-risk transparency.
The U.S. Securities and Exchange Commission has decided to take a different tack on climate-risk disclosures than its counterparts in Europe. Instead of targeting investment managers, the SEC is focusing on the companies they invest in—and the executives who run them.
SEC Chairman Gary Gensler is expected to propose a series of new disclosure requirements for companies by the end of 2021, said Sonia Barros, a partner at the law firm Sidley Austin LLP and a veteran of the SEC’s Division of Corporation Finance, which reviews corporate disclosures.
“It all starts at the corporate issuer level,” Barros said. Gensler “will want to do something now rather than wait for the perfect moment” since investors are already demanding more details from companies, she said.
Gensler provided some insight into the SEC’s deliberations in July, according to Barros.
These Are What She Sees As Likely Components Of The SEC’s Climate-Related Reforms:
* Consistent and comparable disclosures that are mandatory and “ decision-useful” for investors.
* A possible requirement that such details be formally included in Form 10-K securities filings.
* Qualitative disclosures, such as how company leaders manage climate-related risks and opportunities and how those feed into corporate strategy.
* Quantitative disclosures, such as metrics related to greenhouse gas emissions, financial impacts of climate change and progress towards climate-related goals.
These Could Include:
* Scope 1 emissions (produced directly by a company).
* Scope 2 emissions (associated with the purchase of electricity, steam, heat or cooling).
* Though less likely, the regulator is considering disclosure rules on Scope 3 emissions (produced by a company’s supply chain and customers).
Barros added that the SEC is also likely to lay out requirements for industry-specific metrics, including scenario analyses on how a business might adapt to a range of possible physical, legal, market and economic-related changes.
Those would include physical risks associated with climate change as well as transition risks associated with a company’s stated climate commitments, or legal requirements in the jurisdictions in which they operate, Barros said.
And speaking of commitments, she said the SEC is likely to want more transparency when it comes to:
Disclosures Supporting Forward-Looking Commitments, Such As:
* “Net-zero” commitments or other climate pledges or commitments required by jurisdictions in which companies operate.
* The SEC is also considering which data or metrics companies might use to inform investors about how they meet those commitments.
Meanwhile, to clamp down on greenwashing, the SEC has set up the 22-person Climate and ESG Task Force to look for misstatements and material gaps in climate-risk disclosures under current rules. This increased focus will likely result in additional disclosure proposals for the fund-management industry in the spring of next year, Barros said.
“Europe is definitely moving forward more aggressively on this front than the U.S.,” she said. Based on Gensler’s comments, she said, the SEC will focus solely on what’s appropriate for the local U.S. market.
If Gensler’s testimony this week before the Senate Banking Committee is any sign, there’s no mistaking the fact that he’s planning to bring significant scrutiny to financial industry claims.
The SEC has “seen a growing number of funds market themselves as ‘green,’ ‘sustainable,’ ‘low-carbon,’ and so on,” Gensler said Tuesday. “I’ve asked staff to consider ways to determine what information stands behind those claims, and how we can ensure that the public has the information they need to understand their investment choices among these types of funds.”
A Quant Investor Uses A.I. To Track Down Corporate Greenwashing
By analyzing how executives talk about their sustainability efforts, Acadian’s Andy Moniz hopes to figure out who’s full of hot air.
As sustainable investing becomes more mainstream on Wall Street, companies are doing everything they can to present themselves as eco-friendly and ethically run.
But the environmental, social, and governance (ESG) ratings that money managers rely on don’t always do a good job of cutting out the greenwashers—businesses that talk a good game but don’t match it with action.
Andy Moniz, a London-based data scientist at Acadian Asset Management, says he’s not only figured out a better approach, he can make money trading on it. He’s using such sophisticated tools as natural language processing and machine learning to figure out what companies are really up to. “I became frustrated with what the ESG data providers were doing,” says Moniz.
“A lot of the time they’re just relying on yes or no answers to questions like ‘Does this company have a human rights policy?’ That data is extremely stale and backward-looking.” He felt he could do a better job collecting the data on his own.
A Bloomberg Businessweek investigation published in December showed that rather than reflecting companies’ sustainability efforts, ESG ratings tend to focus narrowly on risks to shareholders.
So a company could have high carbon emissions but still get a decent ESG score if stricter regulation of its business appears unlikely.
Moniz, too, is looking out primarily for investors’ interests in his analysis. But even based on that kind of metric, ESG ratings fall short, Moniz says. (Bloomberg LP, which owns Bloomberg Businessweek, sells sustainability ratings and data to the investment industry.)
At Acadian, a quantitatively-driven fund with more than $100 billion under management, Moniz analyzes reams of data about companies to identify hidden ESG risks.
Some of it is unconventional: For instance, his software searches through transcripts of executives speaking at shareholder meetings, conferences, and on analyst calls for signs of evasiveness, vagueness, or a refusal to answer questions. It’s an approach grounded in psychology literature.
He gives the example of Albert Chao, president and chief executive officer of Houston-based Westlake Chemical Corp., who earlier this year was asked by an analyst to explain his firm’s decarbonization strategy. “This issue is very important for the company, its employees, and the whole world,” Chao replied.
“We want to do our part as much as we can. … And I know to get to zero net emissions, that’s a tall order. And a lot of work is being done on that. But I think with still a lot of progress to come out, and we are very conscious of it.” That meandering response was flagged by Acadian’s algorithm as a “non-answer.”
Then there’s Russian miner Evraz Plc, whose then-CEO, Alexander Frolov, was asked in August how he planned to reduce the company’s carbon footprint. “We have lots of opportunities, let’s say, to capture it and utilize, which we are not doing at the moment,” he replied.
“And I guess this would lead to significant reduction of greenhouse … there are different strategies, but there is potential on both sides to reduce greenhouse emissions in the future.” This, says Moniz, is a classic example of vagueness—something he says is depressingly common among companies.
Companies today put most of their ESG information into carefully worded sustainability reports, but nuggets are to be found in these, too, says Moniz.
He points to the Polish coal-fired electricity company Ze Pak SA, which claimed in a recent presentation that by 2029 it would achieve “climate neutrality”—an even more ambitious target than net-zero—without providing any clues as to how it planned to do so.
“We are ahead of the goal of European Union climate neutrality (2050) by 20 years,” the company declared. Ze Pak, Westlake Chemical, and Evraz did not respond to requests for comment.
Recognizing red flags when they’re right in front of you isn’t too difficult. The challenge lies in building a system that can trawl through millions of documents from disparate data sources relating to thousands of companies, as well as teach itself what to look for. Even harder is translating that system’s findings into investment returns.
In the lead-up to the financial crisis, a handful of investors figured out that mortgage-backed securities were riskier than they seemed to be and made money betting against them.
There is no such straightforward trade for greenwashing because, even when companies are found to be inflating their sustainability credentials, there’s no guarantee their shares will go down. In fact, history suggests hedge funds have benefited by investing in sin stocks ESG investors won’t touch.
Moniz and his team focus only on those environmental, social, and governance issues that their analysis suggests will feed into the bottom line. “Our investment process is purely designed to enhance risk-adjusted returns, and in that way we don’t treat ESG as any different to any other dataset,” he says.
It’s a mindset Moniz developed on Wall Street at the likes of Citigroup Inc. and Deutsche Bank AG, where his role was to hunt for profitable trading signals in places others might not look.
One project involved building a portfolio that mirrored the trading of executives in their own company’s stock. Another saw him comparing how large the CEO photos were on annual reports—and how frequently they were updated—as a test for egotism and therefore, management quality. (The results were inconclusive).
Moniz turned his attention to the “G” in ESG for a Ph.D. in 2015, when he developed a program that graded companies by the language used on the job review website Glassdoor.com. (In corporate jargon, governance refers to how well a company is run internally.)
The resulting paper, which was published by the New York Federal Reserve, found that companies whose staff members are both content and find their work challenging will outperform their peers.
Acadian scores companies on metrics including greenwashing, corporate culture, labor relations, and whether management is focused on the long term. The data are fed into a larger computer model that makes decisions on what shares to buy and sell.
Companies that are badly run are downgraded, not because they’re unethical but because Moniz’s analysis indicates that the quartile with the best governance scores has outperformed peers by 9% annually over the past decade. Acadian’s Global Equity funds returned 19.2% in 2020, beating the MSCI World Index by 3.3%.
To boost its chances of success, Acadian has started engaging with companies for which it has identified ESG issues. Last year, for example, Volkswagen AG was named by a human rights group as having exposure to forced labor camps in China’s Uyghur region.
After VW issued a statement denying the report, Acadian’s algorithm hunted through the company’s documents, media reports, transcripts, and alternative data sources to come up with a detailed chart of all its vendors and customers.
The analysis suggested VW did have one remaining supplier from the region—something the company said it would look into. Volkswagen says in a statement that it “found no evidence” of forced labor in its supply chain in China, and that “no parts” from any company mentioned in the report are used in its vehicles.
“This wasn’t about ESG for the sake of it,” says Moniz about why he flagged the potential issue. “If the company became embroiled in a scandal in the press, it would have impacted the share price.”
Regulators have started waking up to the shortfalls of ESG ratings. Authorities in the U.S. and the U.K. are introducing more standardized sustainability disclosures.
Last month, the International Organization of Securities Commissions, an umbrella group for the world’s regulators, published a report decrying the industry’s “lack of transparency” and proposing greater scrutiny.
Moniz is not worried that such moves might undermine Acadian’s edge. “The key question still remains: How credible are companies’ targets and commitments,” he says. “Talk is cheap.”
Gas Giant In Korea Accused By Activists Of Greenwashing
* Group Brings Action Against SK E&S For ‘CO2-free LNG’ Claims
* Activists Are Seeking More Legal Recourse Against Energy Firms
South Korea’s largest private gas provider SK E&S Co. is facing legal action from a climate activist group alleging that it falsely advertised the green credentials of a project in Australia.
Solutions for Our Climate said it’s bringing a claim against SK for labeling liquefied natural gas from its Barossa project off the northern coast of Australia as “CO2-free.”
While SK claims to capture greenhouse gases produced while making LNG, it’s only partially removing emissions from the process and not doing anything about CO2 released when the gas is burned, which is where the vast majority of emissions come from, the group said.
SK will use carbon capture and sequestration to eliminate 60% of its share of the emissions from the project, which amounts to 4 million tons a year, and will grow forests to offset the rest, Kim Hyejin, communications executive officer at SK E&S, said by phone.
“As a major LNG supplier in South Korea, we’re trying our best to stay responsible by actively investing in clean technology such as CCS to help reduce emissions and be part of the transition toward net zero,” Kim said.
The action, which is the first claim in South Korea against a company on its emissions, comes as environmentalists across the globe are increasingly taking legal recourse against big fossil fuel suppliers.
Earlier this year, Royal Dutch Shell Plc was ordered to cut emissions faster than planned, while Australia’s Santos Ltd. was challenged by an activist group for making a misleading net-zero pledge.
“There is no such thing as ‘CO2-free LNG,’” Oh Dongjae, a researcher at SFOC, said in the statement. “SK E&S has oversold its CCS technology as a silver bullet.”
Seoul-based SFOC said it’s taking the case to the Korea Fair Trade Commission and the Ministry of Environment, which will decide whether to go forward with an investigation.
SK plans to spend $1.4 billion developing the Barossa-Caldita gas fields in Australia, in which it has a 37.5% stake. It expects to produce 1.3 million tons of LNG annually for 20 years from 2025, and to use carbon-capture technology to remove CO2 emitted from its LNG plant and inject it into a nearby marine waste gas field, the company said in a March statement.
If the technology works, that will remove about 2.1 million tons a year of emissions, the group said. Another 11.4 million tons a year will still be emitted, mostly from burning the fuel as well as transporting it across oceans, it said.
Banks Get ESG Upgrades Despite Lending Billions For Fossil Fuels
Wells Fargo, Citigroup, Morgan Stanley received a boost in their green credentials from MSCI, even after providing $74 billion to polluting companies.
The world’s leading rater of green credentials is rewarding some of Wall Street’s biggest banks even though they continue to lend billions of dollars to fossil-fuel companies.
Those credentials come in the form of upgrades from MSCI Inc., which ranks corporations globally on environmental, social and governance criteria. In the past two years, Wells Fargo & Co., Citigroup Inc. and Morgan Stanley were among banks that got an ESG headline-rating upgrade for environmental reasons, even though the three banks arranged a combined $74 billion of loans for fossil-fuel companies.
Climate change, racial inequality and the growing wealth gap have created huge demand for ESG data on global companies.
Adjustments to ESG ratings, which investors use to trade shares in a booming market for sustainable investing, can affect the flows of money invested in a company’s stock. Some $2.7 trillion now sits in sustainable funds, more than triple the amount from two years ago, according to research firm Morningstar Inc. That sum is expected to continue growing at a rapid pace.
Bloomberg News analyzed MSCI’s ESG rating upgrades given in the past two years to lenders in the S&P 500, a representative sample of companies in the world’s largest economy. The analysis found that 13 of 22 banks got upgrades, and almost half of those were because MSCI analysts took into account a “more granular breakdown” of the banks’ loans — meaning which industries get their loans.
Only three of the 22 lenders got an ESG rating downgrade: Zion Bancorp, Signature Bank and M&T Bank Corp.
Rather than measuring the total sums loaned to high polluters, MSCI analysts focused on how much those loans accounted for in a bank’s lending portfolio.
For example, if a bank lent billions to an oil company but those loans represented a small part of its overall lending, MSCI would consider the bank to be greener — and worthy of a rating upgrade — compared with one that lent millions but whose loans accounted for a larger part of its overall portfolio.
Analysts at MSCI found that six firms — Wells Fargo, Citigroup, Morgan Stanley, Truist Financial Corp., Regions Financial Corp. and U.S. Bancorp — had only a small proportion (about 10% or less) of their total lending going to polluting businesses such as oil, gas and power companies or miners.
What mattered more isn’t the total sum lent to these corporations, but the lending portfolio’s “environmental intensity,” which is how much environmental harm the firm could be on the hook for per dollar lent across its entire portfolio.
JPMorgan Chase & Co. was the only S&P 500 bank whose ESG rating upgrade in 2020 was driven largely by its green-lending practices. MSCI analysts noted that its green bond issuance in 2019 stood at levels “besting industry peers.” Since the Paris Agreement was signed in 2015, JPMorgan has underwritten more bonds for fossil-fuel companies than any U.S. bank.
The company also ranks as the leading underwriter of green bonds in the same period among its domestic peers, according to data compiled by Bloomberg.
MSCI, which markets its ratings as a way to “build better portfolios for a better world,” said its ratings are tied to “relevant ESG risks.” MSCI’s ESG ratings measure how government regulations, legal judgments or other factors will affect those companies’ bottom line, rather than the risks the companies’ activities might pose to the world — a fact revealed by a Bloomberg Businessweek investigation published in December.
In a statement, MSCI said its ESG ratings “are used by institutional investors to better understand a company’s exposure to financially relevant ESG risks, not to measure a company’s total climate impact — we have other tools and data for that purpose. We are explicit about this investment management purpose and investors using our ratings understand and agree with our approach.”
But in a November interview responding to the Bloomberg investigation, MSCI Chief Executive Officer Henry Fernandez said even “many portfolio managers don’t totally grasp that.”
While the approach of considering risks to the company’s bottom line is an industrywide practice among ESG data providers, Bloomberg Intelligence estimates that 60% of all the money retail investors have plowed into sustainable or ESG funds globally has gone into ones built on MSCI’s ratings.
So changes to those ratings can have outsized impact compared with ESG scores from competitors such as Sustainalytics or Bloomberg LP. (Bloomberg LP, which owns Bloomberg News, also provides ESG data and scores; it has a partnership with MSCI to create ESG and other indexes for fixed-income investments.)
In response to this article, MSCI said it takes into consideration the reputational risks that lenders face tied to their absolute sums lent to fossil-fuel companies. But its in-depth reports don’t explain exactly how the assessment feeds into the ESG rating.
Consider the example of Wells Fargo. The bank was the largest lender to fossil-fuel companies during the past two years, helping arrange $41.5 billion of loans, according to data compiled by Bloomberg. MSCI analysts found that Wells Fargo is only “involved in moderate controversy” tied to its lending to polluting industries and that its decision-making process for “incorporation of environmental due diligence” is in “line with industry best practices.”
Officials at Wells Fargo declined to comment.
Apart from the six banks that got headline-rating upgrades driven by loan-portfolio analysis, five other lenders in the S&P 500 got ratings upgrades from MSCI without taking any meaningful action. Instead, it was the result of MSCI changing how it calculates underlying scores of those lenders relative to peers.
Those upgrades coincided with a spectacular run for the stock price of most Wall Street firms as global markets recovered thanks to economic stimulus from governments responding to the pandemic.
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