Can greenwashing be avoided?

We explore the growing dangers of greenwashing and what steps advisers can take to better protect themselves and their clients.

Environmental, social and governance (ESG) investing has gone from niche to mainstream. Once just a means of avoiding certain unsavoury industries, ESG has grown into a wide-ranging concept that incorporates many different sectors and values. As such, it is becoming increasingly important for advisers to clearly understand the many different facets of the ESG market.

As the definition of ESG expands and the market grows, one issue receiving a lot of attention is ‘greenwashing’.

Greenwashing is the practice of providing a misleading image of a company or investment product’s ESG credentials. This has resulted in increasing concerns over companies offering purposely incomplete, unsubstantiated, or even false ESG information to disguise bad business practices. The issue is further compounded when fund managers are tasked with constructing portfolios that pool together many different companies in pursuit of a client’s ESG objectives.

The dangers of greenwashing

There are pressing reasons why greenwashing is such a concern. If a product fails to advance the ESG causes it claims to champion, then progress and improvement in these areas will stall. This can lead to a false sense of ‘everything is ok’, and ultimately have very dangerous consequences for the environment and society.

Greenwashing can also have a significant impact on the financial services sector. The Global Financial Crisis left a mark on the industry that isn’t fading quickly. Adding ESG factors to financial products is of course a great way to help the planet and win back public trust. However, if greenwashing is allowed to prevail and ESG found to be anything short of authentic, it could be equally as devastating for the sector’s reputation.

Finally, greenwashing is playing an increasingly important role in the adviser-client relationship. Such investments for clients are often a balance between achieving their ESG values and reaching their investment targets. With advisers having a duty to ensure fair outcomes for clients, it’s vital they can trust ESG funds in order to provide guidance with confidence.

Quality data is the solution

Access to trustworthy information and improved understanding can help both advisers and clients better avoid greenwashing. ESG funds come in all shapes and sizes, from those eliminating ‘problem’ industries such as oil and tobacco, to funds looking to actively improve the planet. It is therefore important for advisers to learn these differences so that they can explain these to their clients.

Not only do advisers need access to ESG research, but they must be able to trust this data. Advisers are recommended to review their fund research processes, including due diligence practices and where ESG data is sourced, to help safeguard ESG data quality.

The evolution of ESG

With the ESG landscape still evolving, it’s important to stay up to date with the latest products, trends, and challenges. ESG regulations are also likely to tighten in the future, with the FCA already beginning to put the sector under greater scrutiny. While improvements in fund standardisation and transparency, as well as guidance from the regulator, are helping to give advisers and clients needed clarity, much more is still required.

While most ESG investment products are well-intentioned, advisers need to stay alert as more and more asset managers reposition and ‘relabel’ their strategies as sustainable. A typical ‘red flag’ for example would be a ‘green’ portfolio containing fossil fuel or gambling companies. In such instances, advisers need to think critically about how such funds justify their inclusion and whether such a portfolio accurately reflects their client’s ESG values.

As demand for ESG products continues to rise, greenwashing is predicted to become a growing problem for advisers. While better regulatory oversight in the future will help reduce greenwashing, advisers for now need to play a leading role in researching the ESG funds they recommend to clients.

If left unchecked, greenwashing has the potential to erode the trust between clients, advisers, and the entire financial advice sector, not to mention cause lasting damage to our society and planet. Whilst daunting, it’s not all doom and gloom. The ESG sector has enormous potential to do good, both in terms of protecting our planet and creating new investment opportunities. Access to quality data that can be trusted will play a vital role in this.