The framework that fund managers use, which takes material ESG considerations into account, relies on an investment and ownership process that can be difficult to verify, although it has produced visible results. That includes the recent election of dissident directors at Exxon Mobil Corp. REUTERS/Lucas Jackson/File PhotoLucas Jackson/Reuters
Given the recent surge in interest among Canadians who want to invest in a responsible manner, and the increasing number of products that aim to address these concerns, financial advisors who recommend responsible investments to their clients face a significant challenge in determining whether they live up to their claims.
Evidence of “greenwashing,” or giving a false impression that an investment is more responsible than it truly is, is pervasive. For example, the European Commission (EC) conducted a study earlier this year to determine the merit of green claims that businesses in sectors such as garments, cosmetics and household equipment made online. It found that in “42 per cent of cases the claims were exaggerated, false or deceptive and could potentially qualify as unfair commercial practices under [European Union (EU)] rules.”
The challenge advisors face in determining cases of greenwashing can be broken down into three related areas: claims made by investee companies; claims made by funds that invest in the companies; and claims made about the investment process or strategy.
First, many corporations seek to maximize profits through branding at both the product and corporate level: environmentally friendly products are often preferred among consumers and may command a premium price. Furthermore, brand value can add hundreds of billions of dollars to a company’s stock market valuation.
For example, Forbes estimates Apple Inc.’s brand value at US$241-billion. The incentive to put the rosiest – or, in this case, the greenest – spin on products is enormous.
Naomi Klein’s 1999 book No Logo challenged corporate-level branding, claiming it glossed over or “greenwashed” many companies’ deleterious environmental and labour practices. She highlighted a continuing challenge – the lack of standardized data with which to measure, compare and analyze companies’ activities.
Many efforts are under way globally and locally to remedy the data gap, including for the following: carbon footprints (CDP); labour practices (the Workforce Disclosure Initiative); and board diversity (Ontario’s Capital Markets Modernization Task Force). The emerging environmental, social and governance (ESG) data will allow investors and regulators to determine the veracity of corporate claims more accurately, just as the EC did in its review of green product claims.
A second greenwashing challenge arises at the investment fund level: the lack of standard definitions or taxonomy. The CFA Institute recently published its draft ESG Disclosure Standards for Investment Products, which will lead to finalized global standards later this year that “provide greater transparency and comparability for investors” and allow “asset managers to clearly communicate the ESG-related features of their investment products.”
The global standards should encourage many regional product certification or labelling initiatives, perhaps similar to the EU’s Sustainable Finance Disclosure Regulation (SFDR), which provides sustainability ratings at both the company and fund level. Canada’s approach is likely to account for our particular industrial and regional structure, but the outcome – an alignment of fund holdings and fund labels – should be equally effective. The ultimate goal in both the EU and Canada – and of responsible investing in general – should be the direction of capital toward better ESG outcomes.
The third area that can attract claims of greenwashing are the two investment frameworks that fund managers employ. One integrates material ESG considerations into the analysis and valuation of securities, then relies on proxy voting and engagement with companies to nudge them to better ESG outcomes. The other screens portfolios to avoid “bad” or include “good” companies or industry sectors.
The framework that takes material ESG considerations into account relies on an investment and ownership process that can be difficult to verify, although it has produced visible results. That includes the recent election of dissident directors at Exxon Mobil Corp. XOM-N.
The second screening framework is more easily verifiable. The companies held in a fund must be consistent with that fund’s marketing materials – it’s the approach the EU has taken. Provincial securities commissions in Ontario and British Columbia, as well as the Securities and Exchange Commission in the U.S., are currently examining the responsible investment claims of a select number of investment firms.
While there’s a great deal of frustration in the fact that these two frameworks don’t align better, it only underscores the importance of having a clear taxonomy and clear reporting and metrics at both the company and the investment fund level.
For advisors, this difference also reveals the importance of having in-depth discussions with clients about their expectations. Is their goal to engage companies for improved outcomes or to align their morals and their investment holdings?
The proliferation of investment products and claims presents a challenge for advisors, but it’s one that’s being met by increased corporate disclosure, a standard taxonomy for investment funds, and increased regulatory oversight.
Ian Robertson is vice-president, director and portfolio manager at Odlum Brown Ltd. in Vancouver. He also served as chair of the Responsible Investment Association’s board of directors.