As ESG investment has soared in recent years, so too has scrutiny of the labelling of funds and financial products.
Today, those who make misleading claims about their ESG credentials will find themselves in the crosshairs of regulators such as the FCA and the CMA as well as consumer watchdogs like the Advertising Standards Authority, who are taking greenwashing very seriously.
At the same time, the EU’s Sustainable Finance Disclosure Regulation now imposes extensive reporting requirements aimed specifically at eliminating greenwashing from the financial markets and directing finance toward truly sustainable activities.
As green litigation against corporates hits a record level and is predicted to zero in on the financial sector in time, the need to mitigate against the risk of greenwashing is critical for any entity selling ESG-badged products who wants to avoid reputational, financial and legal jeopardy.
Why focus on the ‘G’
Governance tends to get significantly less limelight than the ‘E’ and the ‘S’ of ESG.
But as every firm is now expected not only to stand behind any ESG badging and also provide the kind of evidence that will satisfy a regulator, watchdog or court, governance is the key to managing the greenwashing risk.
That is because the demands of good governance are nearly entirely aligned to the kind of oversight processes that financial firms must have in place to justify ESG claims.
Four areas for action
For any oversight to be reliable it must be based on solid foundations and for most firms this will involve a substantial transformation in four key areas:
- Compliance and risk management: The ESG landscape is not only potentially vast but it is complex and fast-moving. Firms must not only identify the regulations and laws which apply to them today but put in place a governance framework that ensures they are ready to respond to future change and identify emerging risk.
- Knowledge and culture: A world where both investments and exits are dominated by ESG considerations means that ESG knowledge must be considered a core capability for any firm that wants to attract capital, make the right investments and manage risk. This requires a dedicated plan to build and maintain that capability, across an organisation and not just among ESG specialists so it is a part of a firm’s culture. ESG skills and capability must then be checked and monitored.
- Reporting and accountability: Good governance demands that organisations are able to shine a light on how decisions have been made, what data was used and who is responsible for making decisions. This requires clear guidelines for ESG reporting and assigning specific responsibility to individuals for checking, auditing and signing off underpinning data or statements.
- Transparency and disclosure: A key element of the Principles for Responsible Investment, which guides best practice in ESG integration for investors, is to report on the activities undertaken and progress towards their implementation. This will require a shift in the way many firms approach their communication with stakeholders to one which is proactively transparent and involves a greater degree of direct engagement around any questions they may have about ESG-related claims and reporting. This will involve new processes for communications and compliance which can be checked and monitored.
While some firms may already have quite sophisticated processes and governance for one or more of these areas, it is only by auditing and putting in place the right processes across a whole organisation that a firm can reliably reduce the risk of greenwashing and be sure that what is being measured and monitored is meaningful from the perspective of good governance.
This is particularly important because in some instances, greenwash may not be an intentional deception but rather a by-product of a lack of sophistication or underlying knowledge of ESG, a result of putting in quick fixes or one-off solutions or an insufficient scrutiny or scepticism.
While it is critical to mitigating the risk of greenwashing claims, the G of ESG shouldn’t just be seen through the lens of compliance and managing risk.
Firms with a commitment to good governance will be able to strengthen their brand, attract more business and position themselves as genuine leaders rather than followers in the increasingly noisy, crowded ESG space.
