This article is sponsored by Morningstar.
Greenwashing has become the most dreaded term in the sustainable investing sector. Thomas Kuh, head of ESG strategy at Morningstar Indexes, and Anne Schoemaker, director of ESG products at Morningstar Sustainalytics, discuss how the evolution of regulations may help to combat greenwashing. They tell us that the use of the right tools is key to helping investors avoid any link to greenwashing accusations.
What is greenwashing?
Thomas Kuh: Greenwashing refers to misleading claims about environmental and sustainability characteristics by corporations or asset managers. Companies engage in greenwashing by making false or exaggerated claims about their sustainability practices and operational impacts. Asset managers do so by attaching misleading names to their funds or mischaracterising how they integrate sustainability considerations into their investment process.
Misleading investors about sustainability may not be intentional. The industry, up until very recently, wasn’t regulated – meaning the standards for appropriate representation of funds and appropriate disclosure by companies have been a work in progress. But now that investors, fund managers and corporations are aware of greenwashing, there’s no benefit to intentionally engaging in the practice. As standards and rules are defined and tightened, we expect the issue to be addressed in a way that improves outcomes for a range of stakeholders.
Why is greenwashing a concern? How widespread is this issue?
TK: Greenwashing by companies may favourably bias their evaluation by ESG rating agencies. Greenwashing by fund managers may induce investors to select one fund over another.
Investor concerns about greenwashing emerged as sustainable investment achieved critical mass in recent years, with high asset flows accompanied by new product launches. On the supply side of the equation are the new entrants into the market: fund managers selling products that they position as sustainable investments.
New investors are also coming into the market, attracted by their desire for investments that contribute to more sustainable outcomes.
Many managers with long track records in sustainable investment have well-developed expertise and processes in this area. More recent entrants may not have the same level of expertise and experience.
We should distinguish between greenwashing based on an intent to deceive – which I don’t believe is widespread – and greenwashing that results from a lack of clear standards for promoting sustainable investments. Both types are legitimate concerns. However, we expect that they will diminish over time as they are addressed by regulators. With rules governing corporate disclosure becoming more prevalent, we anticipate assessments of companies’ sustainability will become more accurate.
Anne Schoemaker: We all know we’re not on the right track yet when it comes to the Paris Agreement to mitigating the risk of severe biodiversity loss, or other environmental and social goals.
Ultimately, if investors want their money to go towards those goals but don’t have the right information to make informed decisions on sustainable investments, it undermines trust and it may slow down the redirecting of capital flows towards those goals.
How do you think greenwashing contributes to the evolution of sustainable investing?
TK: Sustainable investment has come of age in recent years. Its growth in scale, combined with new regulations, have integrated it into mainstream finance. Concerns about setting appropriate standards is a natural part of the evolution of the field. Ultimately, I think greenwashing can be seen as an outgrowth of the field as it has matured. While some degree of greenwashing is likely to persist, it’s a stage the market should transcend.
Data and research providers play an important role by helping investors accurately evaluate what sustainable funds offer. Morningstar has offered investors sustainability ratings on funds now since 2016. In addition, Morningstar’s evaluations of the funds’ industry – looking at asset flows, AUM and creation of new funds – includes reports looking specifically at sustainable investment funds, such as the Global Sustainable Fund Flows reports. These reports are published to give investors the tools to evaluate what they’re investing in.
How are regulations affecting greenwashing?
AS: Regulation is a necessary step in this market’s evolution, and indicates a level of maturity and ‘mainstreamness’ of ESG and sustainability. It serves multiple objectives like reducing greenwashing risks and redirecting capital towards sustainable goals, particularly climate, which is a priority across all regions. Regulations are clearly seen as an important tool, especially in the EU, and the advent of the EU Action Plan on Sustainable Finance has seen a huge momentum on this front. The EU Action Plan’s regulations and other initiatives have certainly made ESG and ESG risk management much more mainstream – there is much more transparency and disclosure on the topic.
However, not all elements in the EU Action Plan necessarily work as intended. There are concerns that some of the disclosure requirements may actually increase the risk of greenwashing. There’s still a lot of work to be done, as is well understood by the commission and the regulators.
What seems to make rolling out effective regulation difficult is the apparent tension between the objective of reducing greenwashing and the objective of directing capital towards sustainability. Excessive worry about greenwashing may lead to certain things being very tightly defined, which could stifle innovation and make the market more conservative as participants are concerned with potential greenwashing accusations. This may make some policy tools less effective. Conversely, leaving important notions undefined, and up to market players, risks leading to low comparability across important data points, until there is convergence around a market standard.
What role can data providers play in addressing greenwashing?
AS: Sustainalytics has a long history of providing ESG data, research and ratings. This includes offering various solutions related to EU regulations, supporting investors, for instance, with regulatory reporting requirements. Marrying Morningstar’s tools with the full holdings database enables us to provide both issue and fund-level information on sustainability in ESG.
TK: When it comes to greenwashing, regulators seek to protect the interests of investors. But ultimately investors themselves will always have to be diligent. Resources from data providers are essential to this process.
We have made a strategic commitment to provide resources for sustainable investment. Morningstar is integrating sustainability across its different business lines. For example, Morningstar Indexes has a full suite of sustainability indexes, including Paris-aligned benchmarks, based on Sustainalytics data.
We created a sustainable investment framework, which looks at investors’ motivations, approaches to investment, and how portfolios are constructed to achieve particular outcomes. Our ESG research and data provide insights to help investors evaluate which sustainable investment approach is most suitable for them based on their motivations and objectives.