ESG is sometimes just used as a marketing label. In order to avoid so called greenwashing, investors can rely on ESG rating agencies and will need to do some serious due diligence. The key, however, is to first identify what sustainability criteria matter most to you.
This autumn, sustainable finance is going to be the big topic. Globally, because the U.N. climate conference COP26 will take place between October 31 and November 12. But also locally, as there is a huge event taking place in Geneva: the Building Bridges summit, headed by Patrick Odier, senior partner of Lombard Odier group. It has been organized by «Sustainable Finance Geneva» since 2019, and is sponsored by 28 institutions, mostly banks (Geneva private banks are core to the initiative), public institutions and international organizations.
The objective is to «accelerate the transition to a global economic model aligned with the imperatives of the UN Sustainable Development Goals, with finance as a key catalyst for change». The focus of this ambitious sort of Swiss «Green Davos» this year is about «acts, not just words», and «concrete commitments», a message that seems to have been inspired by Swedish activist Greta Thunberg.
Bankers and finance professionals might be genuinely committed; but whether it is, genuine is actually of no importance, because the EU is regulating the sector very strictly and is determined to have most of the financial sector on the continent shift toward sustainable finance by the end of the decade.
At the Swiss investor level, one first step is to be tough on greenwashing. In order to encourage the shift to truly sustainable finance, one must learn to better identify which financial products are really committed to environmental, social and governance (ESG) principles. There is an increasing amount of ESG funds, but sometimes these three letters aren’t much more than a marketing label.
There are several ways for an investor to avoid greenwashing. I spoke to a few experts who act as advisors to pension funds. They warned that ESG is still not a universal standard with generally acknowledged criteria, which makes it difficult to assess the degree of greenwashing, because you need a clear framework to judge that. Still, everyone recognizes that the ESG label can be stuck to products that are not all that sustainable. Since sustainable finance has started to become mainstream, one could come across funds relabeled «ESG» by asset managers for marketing purposes, even while the same old selection remains in place.
A new standard is emerging with the EU Sustainable Finance Disclosure Regulation (SFDR). It requires market participants to disclose precise information about how they integrate sustainability criteria in their investment process. Some funds with an ESG label don’t obtain a sustainable classification under SFDR, which is applicable in the EU since March of this year. Marketing oneself as ESG while failing to be tagged sustainable under SFDR can make you look like a greenwashing operation.
At the investor level, one needs to check whether the portfolio construction or the fund selection is really focused on companies that have a positive impact on society and the environment for a large portion of their activities. One way is to use ESG rating agencies. However, one has to keep in mind that each ESG rating agency applies its own criteria and two agencies might arrive at different conclusions.
A thourough due diligence is key to help investors make sure that funds respect their ESG charters. Granted, most of these investigations are easier for institutional investors than for private clients. Throughout the due diligence process, one can question the fund promoter about the track record of this approach, the human resources committed, the way the analysis is performed, the sources of ESG ratings and the results. The whole point is to look at how deeply entrenched the ESG or impact criteria are in the investment process.
For instance, some asset management firms have employed internal ESG specialists for ten years, while others heavily outsource the expertise. One can also assess the degree of commitment of the asset manager by looking at the firm’s own sustainability score, which can be a good indication of its commitment with the funds it manages. One shouldn’t forget to look at managers’ practices in terms of their engagement with corporate management and its outcomes, and in terms of voting practices. These elements can help separate sustainability from greenwashing.
At the end of the day, you’re better off deciding for yourself which criteria are most essential to you in a sustainable investment before you start looking for corresponding funds. Deciding what matters most will help choose, for instance, between a manager who excludes companies from his portfolio if 5% of their revenues stem from unsustainable activities, and a manager who puts this threshold at 10% of revenues. Investors could also decide if alcohol should be part of the exclusions or not, or if it is preferable to divest fossil fuels or to engage the companies actively to help them transform their carbon foot print.
And finally, a reality check: Often, companies that are slow in converting their practices to sustainability (compared to their claims) are not doing greenwashing but are subject to shareholder pressure into achieving high profit targets. This gives them little room for manœuvre and slows them down. Which only proves, again, that the key is in the hands of investors, the ultimate catalysts for sustainable practices.