Over recent years, ESG and ethical investing have become increasingly popular. In a 2022 report, PwC estimated that around $18.4tn was being managed in ESG funds globally, and companies listed in the US S&P 500 index mentioned ESG an average of nine times a quarter in earnings calls (compared with a maximum of once in 2017).
Commercial Litigation associate Francesca Bugg and paralegal Bruno Ponte look at the interaction between ethical investing and greenwashing and explore current ESG trends.
Institutional investors, such as pension funds, are often required to invest ethically, with an agreed proportion of their money going into such investments. As a result, ESG funds are currently in demand and attracting investment. Between 2020 and 2022, there was six times more capital earmarked for ethical investments (funds that claimed to have high ESG standards) than for other funds.
Navigating greenwashing and responsible investment
Despite this ESG fund boom, it is interesting to see a recent trend of declining engagement from investors who are now pulling out of ESG funds. For example, the Investment Association revealed that investors withdrew £448m from ESG funds in August 2023 alone. Data from Morningstar indicates only six ESG funds were launched in the second half of 2023, down from 55 in the first half of the year.
The row back on ethical investing could be tied to a few factors:
- The difficulty in defining what constitutes ‘ESG’ or ‘ethical’ funds. Currently, there is no regulatory or legal standard definition, ESG ratings are unaudited, and the data on which they are based is often incomplete. A recent study found that more than 70 per cent of those responsible for compiling the data said they did not have confidence in the reliability of their own ESG reporting.
- There is a significant debate about the extent to which ESG investing has an identifiable impact or whether it constitutes greenwashing, with just three in 10 people believing sustainable investments do as they claim. In 2022, the Harvard Business Review identified the crux of the issue: “It’s hard to blame casual observers for believing that investing in an ESG investment fund is helping to save the planet. Marketing materials of ESG funds often make lofty statements about social or environmental aspirations, but the fine print reveals that the real goal is to assure shareholder profits.”
- Last month, it was reported that 2023 was an especially bad year for the performance of ESG funds, with investors pulling $13bn from US sustainable funds, more than offsetting positive flows in Europe and dragging down the market globally.
ESG risks and regulatory change
Companies need to navigate the risk of making misleading statements as regulatory bodies, including the Advertising Standards Authority, the Financial Conduct Authority (FCA) and the Competition and Markets Authority (CMA), are intensifying their scrutiny of companies that exaggerate their various environmental commitments.
For example, the CMA continues to advise the government that certain misleading green claims should be added to the list of banned practices in the Digital Markets, Competition and Consumers Bill. If this bill is made law, the CMA would be able to hand out administrative fines of up to 10% of a business’s global turnover.
Additionally, the FCA has confirmed a substantial package of measures to improve the trust and transparency of sustainable investment products, including new ‘Sustainability Disclosure Requirements’ and an investment labels regime. The measures come after detailed engagement with a range of stakeholders, including industry and consumer groups and other regulators .
In particular, the FCA is introducing the following rules, which come into force on 31 May 2024:
- an anti-greenwashing rule for all authorised firms to make sure sustainability-related claims are fair, clear and not misleading
- product labels to help investors understand what their money is being used for, based on clear sustainability goals and criteria
- naming and marketing requirements so products cannot be described as having a positive impact on sustainability when they don’t.
This is a significant development as this is the first time there will be a concrete anti-greenwashing rule in the financial services sphere.
Future of ESG investing
Despite recent evidence of an ESG backlash in the financial sector, the ESG market is still worth trillions of dollars. It attracts a wide range of investors who increasingly have ethical requirements as part of their investment criteria.
The methodologies underpinning ESG investment are imperfect. Companies must perform a balancing act to avoid falling subject to accusations of either greenwashing or being too tight-lipped, which could be interpreted as an attempt to obscure risks and mislead investors. Instead of making unsupported claims or downplaying challenges, companies should strive for accuracy in presenting their environmental efforts and meeting regulatory requirements. This means providing evidence and concrete examples of sustainable practices rather than relying on vague assertions.
Transparency is paramount. The introduction of the long-awaited Sustainability Disclosure Requirements from the FCA is bound to be a game changer in this sector. As trust is improved in the sustainable investment market, the benefits of ethical investment will be clearly captured and allow ESG funds to return to a more favourable position.
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