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Show us the colour of your money - greenwashing in sustainable finance

Show us the colour of your money - greenwashing in sustainable finance


"Sustainable finance" continues to dominate the legal and financial agenda for many asset managers at the moment, driven by multiple factors, including an emphasis on the climate crisis and an influx of legislation, particularly from the European Union, mandating financial organisations to demonstrate their sustainability credentials.

Despite tightening of the rules (not all of which are yet in force or even finalised), some firms have recently been accused of applying sustainability labels without adequate justification. This has in turn led to increased scrutiny from regulators and is likely to prompt many institutions to consider how verifiable their own green claims are.

The DWS case

Desiree Fixler, the former head of sustainability at DWS, Deutsche Bank's asset manager, has accused the organisation of misleading investors by claiming that more than half of its assets under management were "ESG integrated". Fixler's subsequent statements have included phrases like "propaganda" and "rhetoric". The firm issued a statement rejecting the allegations and standing by its annual report disclosures.

According to DWS' statement, its annual report was clear in distinguishing between "ESG Integrated AuM" and "ESG Dedicated [AuM]", with the former including assets which are actively managed and where ESG data was available for more than 90% of the portfolio. Ms. Fixler, on the other hand, claimed that the integration process was flawed and routinely not followed and that the firm lacked policy and strategy on ESG. DWS' statement went on to say that its assets were being reclassified in accordance with the the Sustainable Finance Disclosure Regulation ("SFDR") in 2021, as reflected in its interim report.

The US Securities and Exchange Commission, the Department of Justice and the German financial regulator, BaFin, have subsequently launched enquiries into DWS' claims, though none have published any details of their activities. This news has, understandably, caused anxiety amongst some asset managers.

Advisor anxiety

The DWS case is not a one-off. Also in August, BlackRock's former Chief Investment Officer published a three-part essay explaining how his view changed from "evangelising" about ESG to "decrying it as a dangerous placebo that harms the public interest". In the past year, Tariq Fancy has become a vocal opponent of sustainable investing, with multiple strands to his argument that it will not have the climate-positive impact it is intended and perceived to have. It is important to note that his criticism is (mostly) aimed at the market more generally than any act or omission by BlackRock - an early adopter of and (arguably) one of the most influential voices around ESG investing.

A 2021 survey of advisors showed that two thirds are nervous of the reputational risks of advising clients to invest in ESG products whose credentials are later questioned. The potential unintended consequences here are clear: far from being a driver of finance towards climate and other sustainability benefits, firms' green claims could ultimately discourage such investment. There are, however, various ways to mitigate these risks for firms. These include a more detailed explanation of the claims being made; in DWS' case, its rebuttal of the accusations focused on the interpretation of the phrase "ESG integrated". Of course, the EU's Taxonomy and SFDR are specifically designed to address problems of interpretation and so adherence to, and disclosures and labelling in line with, their "common language" is one option for European fund managers. Such disclosures are, however, both demanding in nature and extent, and lacking in clarity in the underlying principles (as further discussed below) and consistency in application across EU member states.

UK Government action on finance greenwashing

In the UK, the Government launched its Green Taxonomy Advisory Group ("GTAG") in May 2021 with the stated aim of tackling greenwashing. The UK is not bound to follow the EU's Taxonomy Regulation, but the GTAG is known to be taking the EU Regulation as its starting point. Its priority workstreams are, firstly, localising the Taxonomy, that is overlaying any UK specific pathways and determining what adjustments are needed to the technical screening criteria to better suit the UK market; and secondly, identifying the potential impacts of UK divergence from the EU Taxonomy, such as duplication in reporting efforts.

The GTAG is expected to produce its first set of recommendations to the Government after its second meeting in September 2021.

The Financial Conduct Authority released a letter and guiding principles in July regarding the "clear and accurate" ongoing disclosures expected of funds making ESG-related claims. The letter states very directly that the FCA Is dealing with a number of "poor-quality [ESG] fund applications" which may impact consumers. Various elements relating to the fund may be misleading, including its name, its strategy or the reality of its holdings. In the latter category, the FCA highlighted a sustainable investment fund with significant holdings in two high emission energy companies, with no obvious justification for the mismatch between the fund's aims and its investments.

The guiding principles part of the document contains just three core principles, each to be read in light of the overarching principle of "Consistency":

  1. "The design of responsible or sustainable investment funds and disclosure of key design elements in fund documentation" – the fund's name, financial promotions or fund documentation should fairly represent the materiality of ESG considerations.
  2. "The delivery of ESG investment funds and ongoing monitoring of holdings" – the firm must apply appropriate resources in pursuit of its stated ESG objectives, consistently and on an ongoing basis.
  3. "Pre-contractual and ongoing periodic disclosures on responsible or sustainable investment funds should be easily available to consumers and contain information that helps them make investment decisions".

The document provides a number of clarifications of these core principles as well as examples of expected behaviours.

What firms can do

While there may (or may not) be more to the DWS case than differences in interpretation, it is key for asset managers to be as transparent as possible with investors and advisors, so that the sustainability credentials of the product cannot be questioned.

Those classifying their funds under the SFDR are not being helped in this task by the European Union's failure to clearly define the boundaries of a fund that is "promoting an environmental or social characteristic" (an "Article 8" fund). If, as suggested by current European Commission guidance, the bar for Article 8 funds is set low, and there is therefore a wide range of ambition even within the Article 8 bucket, there is potential for significant confusion over a product's green credentials if the investor does not focus on the detail of the disclosures. Only those who appreciate the detail of SFDR will realise that "Article 8" alone cannot describe whether a fund is "Article 8 but almost Article 6, ie. minimal ESG commitments", or "Article 8 but almost Article 9, ie. high ESG ambition". This is an issue that ESMA has recognised, but at the moment there is no proposed solution. Firms should consider carefully what information to draw out in high level summaries in order to reduce the risk of misleading claims.

Fixler herself has advice for asset managers. She claims that firms marketing themselves as "leading" or "above the industry standard" can cross a line, which resonates given the lack of accompanying definition of these phrases, and a firm's use of labels and taglines which come with neither a regulatory definition nor an accompanying text can easily lead to confusion. She furthermore advocates that firms must be entirely consistent in their messaging: she accuses DWS of representing itself as a market leader to the world but internally acknowledging shortcomings in its ESG strategy. Similarly firms should ensure that they can live up to their own claims (rather than their fund or product claims) which invariably are made by those looking to be an ESG firm of choice.

What's next?

The industry will be watching closely for any announcements regarding the DWS investigations in the US and Germany, to see whether they are, as some predict, the tip of the ESG greenwashing iceberg. Firms looking for easy answers are unlikely to find them – is it better to tone down the ESG claims and risk turning away investors looking for climate or social impact, or to go for a belt-and-braces approach with a detailed explanation and justification of its ESG claims, inviting further scrutiny?

It will also be interesting to see whether the EU Commission further clarifies key definitions within the SFDR; given that the problems discussed in this briefing note are precisely those that the SFDR was conceived to address, there is certainly merit in a regulatory intervention during this bedding-in period. Finally, it remains to be seen whether the upcoming UK Green Taxonomy's alignment (or potential divergence) with the EU Taxonomy will lead to consistency and clarity in approach, or create further layers of "ESG" credentials, muddying the waters even further.

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