Figuring out how you should invest your money is no simple feat.
Now, there’s an extra wrinkle to take into consideration, with growing concern over “greenwashing” in the financial world.
The term is used to describe misleading information about a company’s environmental performance, and it has come into focus as people and governments pay more mind to the impact businesses have on the environment and society.
Corporations and investors are also increasingly considering risks associated with a company’s operations through an environmental, social and corporate governance (ESG) framework.
ESG-related risks range from the carbon footprint of a company, to its labor practices, to the diversity of its workforce.
“Interest in ESG factors, as part of investment decision-making, has clearly been increasing significantly over time,” said Alexander Dyck, a professor of finance at the University of Toronto.
But as authorities, too, turn more attention to ESG ratings and disclosures, debate is bubbling around whether these investments are exactly what they claim to be.
On May 31, German police raided Deutsche Bank as part of a probe into suspected greenwashing by its asset management firm. And more recently, the US Securities and Exchange Commission began investigating similar accusations linked to Goldman Sachs.
In both cases, there are suspicions they overstated the extent to which their investments were driven by ESG principles.
ESG goes mainstream
The increasing interest in ESG is evidenced by the rapidly growing number of organizations who have become signatories of the Principles of Responsible Investing (UNPRI), a United Nations’ supported organization.
More than 4,000 investors have signed on to the UNPRI, with more than $120 trillion US in assets under their management. The UNPRI advocates for six principles of responsible investing, with the first being a commitment to “incorporate ESG issues into investment analysis and decision-making processes.”
There’s also a growing interest in sustainable investing among the public, and young people specifically.
According to the Royal Bank of Canada, their InvestEase business has seen a 56 per cent year-over-year growth in the number of “responsible investing” accounts. More than 50 per cent of the account holders are under the age of 35.
Different types of ‘sustainable’ investing
Sustainable investing is an umbrella term used to describe the different ways of taking into account non-financial factors in investment decision-making.
The most common approach is an integration approach, where ESG factors are taken into consideration in the decision-making of a company or the composition of an investment. This approach may tilt a portfolio in favor of investments that score higher on ESG.
Socially responsible investing (SRI) takes things one step further by excluding certain types of investments altogether, such as alcohol, tobacco or fossil fuel companies.
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Then there’s impact investing, where the goal of an investor is to maximize social good through their investment.
Taking an ESG integration approach is the most common of the three, said Dyck, noting there’s usually a financial cost to excluding sectors or industries from a portfolio.
“[The] exclusion criteria is, I think, a little bit of a tricky path for most investors to fall on, because there’s almost inevitably a cost that you don’t fully understand,” he said.
How sustainable is sustainable?
One of the main controversies around ESG investments is how they are assessed.
Typically, investment managers decide which components of ESG to emphasize and those preferences will drive decision-making, said Diane-Laure Arjaliès, an associate professor at Western University’s Ivey School of Business.
“There’s a range of green and so… something that is ecological for you, may not be ecological for someone else,” she said.
Investment managers will often use ESG data that are developed in-house or by ratings agencies to make their decisions. But the ratings from one agency to another may differ, depending on the weighting of different ESG criteria, which is sometimes another point of controversy.
People often mistakenly assume that the purpose of using ESG criteria is to maximize social good, when, in reality, it’s a framework of assessing risk to a company, says Alexandria Fisher, a sustainable finance expert who has worked for institutional investors and government on ESG .
“There is a fundamental misunderstanding of what ESG ratings are — and I think that’s causing the tension,” she said. “They don’t provide an indication of really how the company is impacting the broader world.”
Last month, for example, Elon Musk called ESG a “scam” after Tesla ranked lower than ExxonMobil on ESG by S&P Global.
Exxon is rated top ten best in world for environment, social & governance (ESG) by S&P 500, while Tesla didn’t make the list!
ESG is a scam. It has been weaponized by phony social justice warriors.
But Fisher said Tesla’s low rating was no surprise for those from the ESG ratings field, because of concerns related to its overall social and governance performance.
“There’s a lot more discussion around climate risk right now and the environmental side, when governance and social are equally important to a company with such an extensive supply chain,” said Fisher.
A movement to standardize ESG
When it comes to individual investors, greenwashing is a big concern, Fisher said, because it’s difficult to do your own research and financial advisors aren’t always well-trained on sustainable investing.
“The biggest change we need is more transparency around the [ESG] information, as well as standardized information,” she said.
Standardized information might be on the way.
On Wednesday, the formation of the Canadian Sustainability Standards Board (CSSB) was announced, with plans to be operational by April 2023. The CSSB will work with the International Sustainability Standards Board to develop international sustainability disclosure standards.
These international standards will be voluntary, said Lisa French, vice-president of sustainability standards at the Auditing and Assurance Standards Oversight Council, one of the two groups that approved the CSSB. Whether they become mandatory would be up to securities regulators and legislators.
“What it does is it ensures that all companies are applying the same set of standards,” said French. “So they’re all asked to — or required to, if they become mandatory — report on the same elements and to use the same methods, metrics and methodologies.”
The development of disclosure standards would be beneficial for companies, ESG ratings agencies and investors, said French, as they would develop a level playing field.
“Having a structured way to approach sustainability considerations, particularly climate change — this is all good news for us as regular citizens.”