Some companies have long sought to mislead the public about their commitments to sustainability, but greenwashing has become more widespread and sophisticated in recent years. Now regulators and investors are fighting back.

The term “greenwashing” was coined in 1986 by American environmentalist Jay Westerveld, after a visit to a tropical resort. The hotel left notes in guest rooms asking them to “help us help the environment” by re-using towels, even as it was building new tourist bungalows over threatened coral reefs.1

Greenwashing comes in a variety of shades. In 2010, the consultancy TerraChoice conducted a study of US retail companies, identifying “seven deadly sins” of green marketing. These included a lack of evidence for green claims; vagueness; irrelevance; outright lies; exaggerations; hidden trade-offs; and the “lesser of two evils” argument, which sees companies argue for the environmental benefits of fundamentally polluting products, such as cigarettes or crude oil.2

Companies have spotted a commercial opportunity amid rising awareness of ESG issues among consumers

More recently, researchers have identified a separate category, “executional greenwashing”, whereby companies market themselves with nature-related colours and imagery to evoke an “ecological” impression.

One reason for the persistence of greenwashing is that companies have spotted a commercial opportunity amid rising awareness of environmental, social and governance (ESG) issues among consumers.

It all comes out in the greenwash?

But greenwashing is risky; companies (and governments) making false claims may find themselves subject to legal action from consumer-rights organisations or other groups. On climate alone, the number of litigation cases has almost doubled from 884 to 1550 since 2017 (see Law and climate disorder for an in-depth look at litigation risk).

New regulation could make greenwashing more difficult. The European Commission is set to introduce rules to police green marketing on consumer-protection grounds as part of its 2020 Circular Economy Action Plan: two new pieces of legislation, including an initiative to force companies to substantiate green claims using standardised methods for quantifying them, could come into force in 2021 as part of a package of measures designed to support the green transition.3

Meanwhile, the US Securities and Exchange Commission (SEC) has stepped up its efforts to combat greenwashing under the new Biden administration.4

Investment risk

While regulation to clamp down on greenwashing is welcome, asset managers have a key role to play in fighting back against the practice, says Jaime Ramos Martin, portfolio manager of Aviva Investors’ Climate Transition Fund.

“Some companies are good at getting high ESG scores even if the reality is different. It’s part of our job to push back and gauge whether those claims stand up.”

Some companies are good at getting high ESG scores even if the reality is different

Asset managers have an obvious incentive to ensure the companies they invest in are backing up their green claims. Greenwashing can result in reputational damage, regulatory fines and a sizeable impact on an investee company’s share price.

For example, Italian oil company Eni was fined €5 million by the country’s antitrust regulator in January 2020 after running a marketing campaign that presented its palm-oil derived “Diesel Plus” biofuel as having a positive impact on the environment, without mentioning the links between palm oil and deforestation. The watchdog also found the advert’s claim the fuel reduced emissions by 40 per cent compared with conventional diesel was misleading.5

Technology could also play a role in enabling investors to expose and push back against greenwashing. A team of Swiss academics recently developed an artificial intelligence algorithm called ClimateBert, which discovered some companies were cherry-picking non-material climate risk data to meet the requirements of the Task Force on Climate-related Financial Disclosures (TCFD), the Financial Stability Board’s reporting platform.6

But from a due diligence perspective, there is no substitute for engaging directly with company executives to determine their commitment to sustainability.

‘Scope’ for improvement

Blatant greenwashing, however, is relatively rare. More often, companies will pledge their commitment to the green transition while lobbying against new climate regulation behind the scenes.

“Asset managers should ensure companies’ public stance on issues like climate change is aligned with their strategies. For example, some companies will talk a good game but spend a lot of money lobbying policymakers to allow them to maintain an unsustainable status quo.” says Thomas Tayler, senior manager at Aviva Investors’ Sustainable Finance Centre for Excellence.

Companies may present themselves as supportive of the green transition while failing to look into their links to polluting activities further down the supply chain

In another, more subtle, form of greenwashing, companies may present themselves as supportive of the green transition while failing to look into their links to polluting activities further down the supply chain. At issue here are the “Scope 3” emissions associated with companies’ customers and suppliers.

A recent report from Oliver Wyman shows that while around 95 per cent of European corporate lending comes from banks claiming to be committed to the Paris Agreement, less than ten per cent of European companies have Paris-aligned targets. Given that over 70 per cent of credit flow in Europe goes through banks, there might be substantially more climate risk in the system than is commonly assumed.7 This may also be the case in the fast-growing sustainable bonds market.

Similarly, some energy companies have begun labelling their products as “carbon neutrally produced”. In April 2021, Swedish oil firm Lundin announced it had sold “the world’s first ever certified carbon neutrally produced oil”. But the company acknowledged the certification only included Scope 1 and 2 emissions from production, not the major Scope 3 emissions caused by the end use of the oil.8

Ripple effects

To ensure companies provide a clearer and more comprehensive picture of their exposure, both credit and equity investors can engage with them to adopt science-based targets for emissions reductions that incorporate Scope 3.9

Companies’ procurement budgets tend to dwarf their direct spending on corporate social responsibility (CSR) initiatives (see Figure 110), illustrating the potential impact of shifting to greener suppliers. Indeed, there are already signs companies that start pushing for emissions reductions across their supply chain can set off positive ripple effects, raising standards across economies.

For example, US tech giant Apple has set ambitious science-based climate targets that require it to green its supply chain; it is calling for its manufacturing partners to switch to 100 per cent renewable energy by 2030. Apple supplier Sony, having recognised it will be unable to meet these targets without greater availability of renewable energy in its home market, has consequently been lobbying the Japanese government to accelerate the transition towards renewables in the country.11

Figure 1: The average procurement budget of a FTSE 100 company is 400 times its spending on CSR
The average procurement budget of a FTSE 100 company is 400 times its spending on CSR
Source: Charlie Wigglesworth, Jennifer Exon, Neha Chandgothia and Andy Daly, ‘Buy social corporate challenge: Year 3 impact report’, Social Enterprise UK, 2019

Greenwashing in finance

The rise in interest in responsible investment has led to concerns that some asset management firms are branding themselves as sustainable investors without doing the necessary legwork to ensure their portfolios are ESG friendly.

Some asset managers have attracted controversy by including “avoided emissions” when calculating carbon footprints

ESG accounting practices among investors have also drawn scrutiny. Some asset managers have attracted controversy by including “avoided emissions” – hypothetical emissions that have supposedly been negated by the firm’s investments in renewable energy – when calculating their own carbon footprints. Climate experts at the Science Based Targets Initiative have deemed this a form of greenwashing.12

Regulators, meanwhile, are beginning to take a closer look at greenwashing in finance. The Sustainable Finance Disclosure Regulation (SFDR), which came into force in the EU in March 2021, imposes tougher requirements on the classification of investment products. Under the new rules, funds are effectively categorised as ‘sustainable’ if they have binding sustainability controls in their investment process, or ‘neutral’ if they don’t. In addition, all asset managers are required to take sustainability risks into account and explain to investors how these are being managed. The idea is to integrate sustainability into all decisions, regardless of whether the investment product is branded with an ESG tag.

The new rules are complex and fit awkwardly alongside some other sustainability regimes

The high-level policy aim behind these measures – to promote clarity and transparency as to sustainability claims – is admirable. But there have also been some criticisms of the new rules, which are complex and fit awkwardly alongside some other sustainability regimes.

Most notably, Tayler argues SFDR is inconsistent with the EU Taxonomy, the European Union’s classification system for green investments. With further regulation in the offing – the UK’s Financial Conduct Authority is developing its own sustainable finance proposals that it says will “at least match the ambition of the EU”, with a focus on TCFD disclosure – it is to be hoped that sustainability reporting requirements will gradually become more aligned.

While more needs to be done to tackle greenwashing, these are steps in the right direction and asset managers should benefit from regulators’ moves to increase transparency and expose climate risk. The fightback against greenwashing has begun in earnest.

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