ESG and its discontents

The huge growth in ESG financial products has brought with it a new degree of scrutiny on the validity and authenticity of these products and their holdings. Particularly high-profile critiques have recently come from former senior members of sustainable investment teams at BlackRock and DWS, flagging the risk of large scale systemic greenwashing in the asset management industry. The latter case at DWS has highlighted the legal risks of greenwashing in the industry, which as this study by the 2 Degrees Investing Initiative last year documented, is a risk that many are potentially exposed to.

These risks stretch out beyond uncertain regulatory risks, to reputational risks and the immediate concerns advisers have related to their MIFID II obligations and the advice they are providing when selecting purportedly sustainable investment products.

Are these critiques valid?

Yes, and they should not be quickly dismissed as merely naysayers pouring cold water on what could otherwise be considered a positive move towards more responsible investing. The risk of greenwashing needs to be taken seriously and is ultimately a healthy and much needed challenge at this point for the entire Asset Management industry. ESG has definitely hit the mainstream and is no longer reserved for a few niche investors, providers and products.

The introduction of the Sustainable Finance Disclosure Regulation (SFDR) and other regional regulations is reflective of this fact. While regulations will provide much needed transparency, it will be over the long term and will require constant raising of the bar from financial market participants rather than settling for regulatory compliance and box ticking exercises.

While there has been push back on SFDR and some of the classifications for what constitutes climate friendly in the EU Taxonomy, there will exist the opportunity to consume far more consistent and comparable data at an asset and portfolio level than we have previously seen. With the growth in Article 8 and 9 classifications, otherwise known as “light green” and “dark green” funds, and the competition this has created, there will also be many more financial products that will be required to provide these disclosures.

As asset managers grapple with SFDR’S Regulatory Technical Standards (RTS), and distributors ready themselves for this inflow of data to incorporate into selection processes and tools, it is clear also that the fund providers need to better communicate ESG outcomes to end investors, as well as regulators. Regulatory and client communications will need to be aligned and avoid greenwashing pitfalls, such as overstating reduced carbon impacts or other positive social or environmental impacts.

The ability to provide succinct and understandable data has historically been difficult and extremely subjective, yet is one of the biggest, most important challenges facing fund providers today. One of the other well documented challenges and critiques here is in choosing the data points to report on where the ESG ratings providers themselves can’t agree (re: Aggregate Confusion: The Divergence of ESG Ratings).

This has the potential to lead to groups simply cherry picking ESG data points or ratings that shed the best light on their investment products, particularly non regulatory reporting. Beyond the greenwashing risk that this entails, and that regulators are demonstrating awareness, the key consideration here will be ensuring the data selected accurately reflects the ESG strategy of the investment product, and also the goals of the end investor. Fully understanding ‘the why’ of a client’s investment motivations will be a critical component in any ESG offering and will then inform the ESG factors and data points to be reported on.

This will require an unpacking of E, S and G and all that it entails from negative screening, to materiality signals, carbon footprinting and portfolio temperature alignment, to measuring positive impacts aligned to the Sustainable Development Goals. This is required not only of the investment professionals, but also of the end client.

Disclosures and reporting are a useful tool in this process, as well as end output. Communicating the ESG performance of a fund will need to rely on more than just the required regulatory disclosures. However, in order to support the product, and the industry, communications will also need to accurately reflect the stated ESG objectives of the fund, with each data point carefully selected for reporting.

At FE fundinfo, we have the requisite regulatory, data and reporting expertise to help organisations satisfy their transparency obligations and ESG disclosure requirements. Whether you are a fund manager seeking an ESG data and ratings agnostic factsheet or regulatory reporting platform or a distributor needing access to EMT (European MiFID Template) or EET (European ESG Template) data feeds aligned to SFDR Level 2 requirements due to take effect in July 2022, we are here to help.