What Does Greenwashing Mean in ESG Investing?

Environmental, social, and governance (ESG) investing is a hot trend among millennials and GenZ. It is a strategy to invest in companies that rank high on measures of their environmental and societal metrics and governance practices.

ESG investing backs companies prioritising the environment and human well-being in their daily operations. The financials of these firms are more susceptible to environmental and social factors.

ESG issues apply to all industries in some ways. Depending on the industry, the challenges can range from climate change and human rights to workplace inclusivity or health and safety.

According to Bloomberg Intelligence, total funds invested in some form of ESG asset will surpass $40 trillion by 2030. The growing interest in ESG investing is also luring less environmentally conscious actors to capitalise on the trend via marketing tactics to exploit investors' best interests.

When a company positions itself as an ESG-compliant entity by offering misleading information about its practices to attract investors, it is called greenwashing. The practice has been a big issue in the ESG sector, given that some of the biggest companies across industries have been accused and fined due to greenwashing. Unfortunately, these actions raise questions about the ESG principles used to align the underlying investments with sustainability goals, thus impacting investor confidence in the industry.

If you are wondering what kind of false claims major corporations make, they can go from fashion brands claiming sustainable use of resources to manufacture their product lines to investment banks falling short of their pledges to phase out financing coal-based projects.

A 2022 survey of CEOs and industry leaders conducted by Harris Poll for Google Cloud revealed that 68% of US executives admitted that their companies are guilty of greenwashing. Furthermore, a European Union-commissioned study published last year found that 53% of ESG claims on products and services are misleading or unfounded, with 40% having no evidence.

One primary reason driving greenwashing could be that ESG has long depended on third-party rating entities to evaluate their bonafides. This practice stemmed from the absence of a unified standard for ESG ratings, which resulted in inconsistencies globally about what qualifies as compliant with ESG principles. The worsening situation left many investors wondering whether they were investing in ethical firms.

However, regulatory agencies worldwide, including the US Securities and Exchange Commission (SEC), are cracking down on firms using greenwashing tactics through uniform disclosure standards.

Sustainability reporting is becoming crucial in corporate compliance as ESG regulations globally continue to increase. However, the EU has been leading the cause with rules that have more severe consequences for businesses violating sustainability and governance standards.

Meanwhile, the US SEC on March 6 also finalised regulations mandating public firms to disclose specific climate-linked data in their annual reports. Standardising and enhancing disclosures will address the prolonged investor demand for consistent and reliable information on companies' climate-related risks. Further, the rules also introduce transparency in how ESG companies manage those risks.

"These final rules build on past requirements by mandating material climate risk disclosures by public companies and in public offerings. The rules will provide investors with consistent, comparable, and decision-useful information, and issuers with clear reporting requirements," US SEC Chair Gary Gensler had said. "Further, they will provide specificity on what companies must disclose, which will produce more useful information than what investors see today. They will also require that climate risk disclosures be included in a company's SEC filings, such as annual reports and registration statements, rather than on company websites, which will help make them more reliable."

The new regulations will become effective 60 days after publication of the adopting release in the Federal Register.

Despite such efforts, ESG investors may still fall victim to greenwashing in corporate advertising. However, several free online tools can paint a vivid picture of a company's ESG claims and progress so that you don't have to rely entirely on the ESG label and advertisements.

The one from MSCI offers insights into a company's ESG goals, accusations, if any, related to ESG violations, and other details like if it is on track to meet the 2015 Paris Agreement's goal "to limit the temperature increase to 1.5°C above pre-industrial levels."

Disclaimer: Our digital media content is for informational purposes only and not investment advice. Please conduct your own analysis or seek professional advice before investing. Remember, investments are subject to market risks and past performance doesn't indicate future returns.