What is the Biggest Concern for ESG Investors?

|In Sustainability & ESG|By Vladi Nikolov

Sustainability & ESG

Imagine you are an ESG investor. You want to put your dollars where they will really make a difference. Chances are that you have an idea how to do that. However, something makes you hesitate. Is the fund or company you are planning to invest in as sustainable as it claims to be? 

In 2015, the world was shocked when it was revealed that German automaker Volkswagen Group had been hiding the true extent of emissions in its cars. It was in September of that year when the United States Environmental Agency issued a notice of violation of the Clean Air Act to the company. 

The agency had found that Volkswagen had intentionally programmed turbocharged direct injection (TDI) diesel engines to activate their emissions controls only during laboratory emissions testing, which caused the vehicles' NOx output to meet US standards during regulatory testing, while they emitted up to 40 times more NOx in real-world driving.

This is an example of greenwashing - an issue that seriously bothers the investment community as it distorts the image of a company as regards its sustainability efforts. In the case of Volkswagen, the corporation had touted the environmental benefits of its cars, while, in reality, they were capable of seriously polluting the air. 

What is Greenwashing? 

According to Investopedia’s definition, greenwashing is the process of conveying a false impression or providing misleading information about how a company's products are more environmentally sound than they really are. Greenwashing is also considered an unsubstantiated claim to deceive consumers into believing that a company's products are environmentally-friendly.

How Much of a Problem is Greenwashing?

Recent research conducted by Quilter showed that greenwashing is investors’ main concern when it comes to responsible investing. 44% of the participants placed greenwashing as their top issue, expressing their worries over the fact that ESG investments are not what they claim to be. 

Eimear Toomey, Head of Responsible Investment at Quilter Investors, commented on the findings: "Greenwashing threatens to undo all the good work and progress that has been made so far in responsible investing. It is crucial that fund groups invest in the way that they say they will, so it is important investors hold them to account on this.”

Another study, performed by Schroders Institutional Investor, in which 750 industry professionals took part, found that 59% of the respondents identify greenwashing as a challenge when selecting sustainable investments. 

Perhaps unsurprisingly, investors also have wider concerns about the quality of ESG information available to them. 53% of the respondents in the Schroders survey noted as a challenge the lack of transparency and recorded data, up from 40% two years ago. 

All these figures are yet another confirmation that self-reported data and limited reliable information are among the biggest issues with ESG ratings - a topic we have discussed at length in one of our previous articles.  

Why is Greenwashing Happening? 

ESG investing has been growing in popularity among investors. So much so that ethical investing can already be considered a mainstream practice in the investment world. This, however, has been exploited by businesses and funds alike who have seen an opportunity to polish their image by trying to appear more sustainable than they are. All in the name of attracting the investors’ attention. 

Alas, these days it is often the case that the perception of a company is determined by how good its marketing and advertising are. It is not always easy to get in-depth information about the true nature of a business beyond what it itself shows to the public. Moreover, given the great importance of advertising, it is somewhat easy to understand that companies are tempted to capitalize on that and present themselves greener than they are. 

One reason why greenwashing has been able to gain such an influence is that there are numerous ESG data providers. And because multiple companies offer ESG evaluations, it can be difficult to know which one to trust, as we discuss here.

This can lead some businesses, such as oil companies, to be included in funds that investors may not have expected. Critics have called ESG and other forms of sustainable investing marketing ploys or scams, noting that sustainability is just a trend that companies are trying to capitalize on.

Examples of Greenwashing

It is not uncommon for large businesses, in particular, to attempt to appear more climate-friendly than their activities show. For example, due to their industry being under constant attack for the resources it exploits, oil and gas companies often resort to heavy advertising to demonstrate a sustainable image. 

Such is the case with the American giant, ExxonMobil. It was only in December 2020 that the company finally set emissions targets for itself. It committed to reducing the intensity of upstream (Scope 1 and 2) emissions from its operated assets by 15-20% compared to 2016 levels, which it says is expected to deliver around 30% in absolute emission reductions for its "Upstream" business. 

ExxonMobil also published targets to reduce methane intensity by 40-50% and “flaring” intensity by 35-45%. Methane is a powerful greenhouse gas emitted during oil and gas extraction, and “flaring” is the common burning of unwanted gas during oil extraction and processing.

In February 2021, the company also unveiled a division called ‘Low Carbon Solutions’ and said it plans to invest USD 3 billion on “lower emission energy solutions” through 2025, focusing on carbon capture and storage.

Today, ExxonMobil says that it captures about 9 million tons of CO2 per year. Yet, this represents less than 2% of its 2019 annual emissions of 730 million tons of CO2. 

While the 3-billion-dollar pledge looks quite impressive in itself, comparing it to the company’s 2018 oil and gas investment plan of USD 210 billion shows that ExxonMobil intends on continuing to spend a lot more on the development of the fossil fuel exploration side of the business. 

It appears, then, that the advent of advertising allows a business to spin a statement in such ways so that it sounds a lot more impressive than its true content. Therefore, you need to scratch the surface of a public claim to find what really hides underneath. 

Further Complications Regarding ESG Investing 

One factor that makes ESG investing complicated is that there are no set regulations or definitions for what makes something “sustainable,” says Karen Wallace, Morningstar’s Director of Investor Education. That means it is up to each investor to determine for themselves what practices are most important in a fund.

Some funds are designed specifically to exclude certain industries, such as tobacco, weapons, oil and gas. A second group can be defined as sustainable sector funds, according to Morningstar, and are built around “green economy” companies in industries like renewable energy or water.

A third group of funds can be considered “core” holdings, meaning they are diversified investments for a long-term portfolio, meant to replace things like typical index funds. The new BlackRock U.S. Carbon Transition Readiness ETF (LCTU), for example, is benchmarked against — and meant to outperform — the Russell 1000. It has similar holdings to the Russell 1000, but BlackRock says it has been constructed to have “almost 50% less carbon intensity” than the index.”

That said, the fund still holds companies like Chevron and Exxon, which sustainable investors might want to avoid.

Wallace recommends that, just like with any other investment, investors read the prospectus of ESG funds they are interested in. This can be done by googling ”[fund name] + prospectus,” or by simply reading about the fund’s aims on its website. This will tell investors what the fund’s objective is and list the companies it invests in. Investors can then make an informed decision whether it aligns with their values.

How to Avoid Greenwashing?

One way to avoid falling prey to greenwashing is to do the hard work yourself. Lina Khan, a Senior Sustainability Specialist for Gensler, an architectural firm, recommends that you look at reports and third-party verification, and generally dig deeper than the mere ‘sustainability’ and ‘green’ taglines. 

ESG funds usually publish impact reports, allowing investors to see the real-world changes their investments make. A fund’s prospectus will also show the individual companies that a fund invests in, so it becomes even easier to 

If you need professional help, you can also work with a financial advisor who has a chartered SRI counselor certification, which is a designation program designed to teach best practices for socially responsible investing. 

Legislative Efforts to Tackle Greenwashing 

March 2021 saw the introduction of new rules by the Sustainable Finance Disclosure Regulation (SFDR) - covering all European Union financial-market participants and advisers, as well as foreigners that market products to EU investors. According to the regulation, these players will be required to start collecting and reporting certain ESG data. The rules demand disclosures on how sustainability risks affect investor returns and, conversely, how investments negatively impact sustainability factors such as climate change.

The SFDR is part of the EU’s broader proposal to redirect capital towards more sustainable businesses. The plan also includes the development of the EU taxonomy. The taxonomy is a classification system, establishing a list of environmentally sustainable economic activities. It provides companies, investors and policymakers with appropriate definitions for which economic activities can be considered environmentally sustainable. 

In this way, it should create security for investors, protect private investors from greenwashing, help companies to become more climate-friendly, mitigate market fragmentation and help shift investments where they are most needed.

A key part of the SFDR is the classification of funds. Article 8 funds are defined as those which actively promote environmental or social characteristics, while Article 9 funds have sustainable investment as their objective, with both categories subject to higher standards of disclosure under the SFDR. A third category of funds, so-called Article 6, is for products where the manager does not deem ESG risks to be relevant to investment decisions or returns and must explain why. 

Under the first stage of the SFDR rules, all asset managers will have to publish information on their sustainability processes. They also have to allocate investment products to three categories recognised as dark green, light green and non-sustainable depending on their climate and social impact. 

As part of the second stage, expected to come into force in 2022, funds will have to report on issues such as carbon footprint, investments in companies active in fossil fuel sectors and exposure to controversial weapons such as cluster bombs.

Naturally, the initiative does not come without its sceptics. Some fund managers have expressed their concerns that they could have unintended consequences. For example, Ashley Hamilton Claxton, Head of Responsible Investment at Royal London Asset Management, said that while the SFDR will result in much more transparency “interesting challenges” might be on their way. 

She argues that investors might be incentivised to punish companies even when they are making progress on ESG issues. For example, in order to report a low carbon footprint, a fund might avoid big energy businesses that have traditionally had high emissions, even if they were working to transform their operations and developing low-carbon technologies.

How Does TenderAlpha.com Support the Efforts Against Greenwashing? 

TenderAlpha.com’s green data is collected entirely from official government sources. This guarantees its credibility and transparency as it clearly shows which companies win the most green tenders in which countries and across which industries. 

Should an investor decide to consult this data, they will be able to identify businesses that are serious about their participation in green tenders, i.e. such whose services truly contribute to one environmental cause or another. 

Therefore, such information provides valuable insights into the actual green capabilities of a specific company and can reassure investors that the business is committed to sustainability.