Investors need to have their guards up against 'greenwashing' overtures

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There is a definite demand for sustainable – or ESG-based – investment options. But investors have some sifting to do before committing their funds. Image Credit: Supplied

‘Sustainable investing’ continues to gather momentum as a fundamental change to the investment industry.

It has gone from one frequently disregarded a few years ago, to one arguably at the start of an environmental, social and corporate governance (ESG) “bubble”, given the rapidly growing capital flows and valuations.

As investor demand has increased, marketing of green or sustainable investment credentials has ballooned as well. So, how can investors understand and avoid the risks of so-called greenwashing?

The Oxford Dictionary refers to greenwashing as the “practice of over-emphasising a company’s environmental credentials, often by misinforming the public or understating potentially harmful activities”. Historically, greenwashing charges have been levelled at companies who have attempted to position or promote their brand as more environmentally-friendly than the reality of their businesses.

Similarly, companies seeking to capitalise on demand for sustainable products have marketed their products with green – or healthy – labels where underlying processes or materials are not. As these organisations have been called out, their reputations have suffered.

Greenwashing risk

Growing investor awareness over the need to address social and environmental issues is driving more interest in sustainable investing. From our recent research about how to successfully transfer wealth, we found almost 60 per cent of UAE respondents felt that responsible investing is now important to them, providing a useful bridge between generations.

In responding to this client demand, and a desire to play a positive role, investment houses are seeing a potential benefit. With a lack of deep knowledge or authentic commitment, there is a risk of greenwashing. As a result, some investors may be misled, inadvertently or not, to buy products where the advertised sustainability approach or outcome do not match the reality.

Understanding and evaluating what investment managers are actually doing is difficult. Without experience or a guide, investors can struggle to navigate the field and select the most appropriate managers.

Regulators to the rescue?

Recognising this issue, governments, regulators and policymakers are starting to step into the field. The EU has been focusing on making the financial system more sustainable. As part of a series of reforms, it has introduced a classification system, or EU Taxonomy, to determine what counts as green and sustainable activities.

Rules have also been initiated for the investment industry, known as the ‘Sustainable Finance Disclosure Regulations (SFDR). These require all asset managers to publish information on how they incorporate sustainability into their investment processes – with the aim of reducing the risk of greenwashing.

In the UAE, regulators have also introduced guidelines on ESG reporting. In 2018, Dubai Financial Services Authority issued the Green Bond Best Practice Guidelines and, in 2019 Dubai Financial Market issued a ESG Reporting Guide. Most recently, the Securities and Commodities Authority (SCA) announced that listed companies will be required to disclose their sustainability reporting.

Taking ownership

With increased disclosures and further industry convergence, investors may find it easier to avoid greenwashing and identify truly sustainable – and green – investments. However, these changes will take time to implement… and normalise.

Moreover, with a flurry of funds being marketed as sustainable, it has become important to recognise those that are worthy of capital. Below are some actions to avoid greenwashing in the interim.

Articulate preferences

It is important for investors to know what they want from their portfolio. In selecting sustainable investments, are investors aiming to avoid companies that don’t align with their values? Or are they looking to use ESG factors to identify better run companies? Or, finally, is the investment designed to mitigate climate breakdown, or support the UN SDGs?

All these options are valid; each has its own sustainability implications so taking time to discuss, consider and articulate preferences is key.

Understand the process, not presentation

Greenwashing is due sometimes unintentionally to the misalignment between what is represented and the reality. One way to avoid this is to query and challenge to understand the underlying process, not just the latest outcomes or portfolio presented. Verifying the depth and robustness of the process is often a simple test to see if there is greenwashing happening.

Trust – but verify

Labelling can make it easier to identify categories of investment approaches; and provide greater visibility and comparability of options. However, having a label does not mean all investments beneath the label are identical in quality. Investors shouldn’t relinquish their own insight and it is always wise to verify before going forward.

Sustainable innovation

While the aim is to understand and avoid greenwashing, the reality is that not every sustainable outcome occurs as intended. To solve the urgent social and environmental problems facing economies, innovation on a large scale will be critical, including in the investment sector.

Hopefully, the risk of greenwashing will diminish and not prevent the flow of more private capital into those opportunities, so that investors can preserve and grow their wealth and make a positive contribution to our world.