Greenwashing – what it is and how to tackle it

Many people have heard of greenwashing. However, definitions and practices remain vague. We take a look at this phenomenon and ask what it means for investors.

Put simply, greenwashing is when a company deliberately overstates its green credentials. And, alas, the practice is common in today's corporate landscape. Perhaps this is understandable. Sustainability has become big business, and companies are under mounting pressure to communicate their environmental record to an increasingly discerning public.

But for investors focused on environmental, social and governance (ESG) issues, determining whether corporate information relating to sustainability falls on one side of the line or the other can be a serious challenge.

According to the Governance and Accountability Institute, an estimated 90% of companies comprising the Fortune 500 Index now undertake some form of sustainability reporting. The story is similar in Europe.

However, in a 2019 speech, Hans Hoogervorst, chairman of the International Accounting Standards Board, said that increased reporting was unlikely to make companies strive to be greener. “We should not expect sustainability reporting to be very effective in inducing companies to prioritise planet over profit,” he said. “Greenwashing is rampant.”

The rise of ESG

Even as recently as a decade ago, relatively few investors would have paid much attention to sustainability reporting. But investing along ESG lines has moved progressively mainstream, with more and more investors now factoring environmental considerations into their investment decisions.

Coronavirus has accelerated this trend. Between April and June of 2020, ESG-type investing attracted net flows of $71.1 billion globally, according to Morningstar. This pushed assets under management above $1 trillion. In the UK, flows between April and July exceeded the combined flows of the previous five years, according to Calastone, the transaction network.

Another factor upping the ante is that investors are increasingly aware that setting and meeting ambitious targets on the environment is often an indication of a well-run business.

Indeed, if a company manages to reduce its energy consumption while maintaining or even increasing production, that directly benefits shareholders. Reducing carbon emissions is not just about saving the planet. Rather, it's often a proxy for good management. This in turn can bring genuine, value-add insight into the quality of an investment.

Yet for all of today's sustainability reporting, many investors feel none the wiser as to a company's true level of sustainability. One problem is that businesses have to report to a broad group of stakeholders. These include employees, non-governmental organisations, customers and regulators. The result is a wide array of information, much of which is of little relevance to ESG-focused investors.

Yet for all of today's sustainability reporting, many investors feel none the wiser as to a company's true level of sustainability.

A second, related problem is that sustainability reporting has evolved piecemeal. This has created a patchwork of information that creates wriggle room for companies while leaving investors confused.

As consultancy firm McKinsey stated: "These frameworks and standards allow businesses considerable freedom to choose their sustainability disclosures". It added: "Investors say they cannot readily use companies’ sustainability disclosures to inform investment decisions and advice accurately".

How can we tackle the problem?

So, what are the most effective anti-greenwashing strategies? The short answer is that it takes a lot of hard work and analysis. Continual assessment and interrogation are key.

Of course, different standards exist. However, sifting through the resulting data provides significant assurance. Indeed, it's harder today for a company to come out with high-level qualitative views that are not backed up by quantitative measures to show what its carbon footprint is. That is a big change.

It is also important to look at the extent to which a company institutionalises sustainability. For example, does it establish board oversight for green issues? Does it link executive remuneration to reducing carbon emissions?

What about the interrogation part of anti-greenwashing? Here, staying invested in a company and having the ability to ask questions of management can help unearth the story behind the numbers. One example is a company that always meets its sustainability targets versus a company that is only just missing them. The former may be setting soft goals while the latter could be pushing itself ever harder.

This is why we believe company visits are the single-most important aspect of a good anti-greenwashing strategy. Sustainability data is a helpful tool for interrogating a company's track record. However, the full picture is sometimes more nuanced. It is only by engaging with key personnel can you truly understand how a business mitigates its material ESG risks.

You can find more on these topics in our white paper Investing in a Changing Climate or on the dedicated climate change page of our site. You can also find our Paris alignment – our approach for investments document.