Regulators and rating agencies are getting tough on companies making misleading sustainability claims. But it’ll take more than AI and fresh reporting requirements to put a stop to this pernicious practice
In 2015, Volkswagen spent $77m (£65m) in the US alone touting its diesel cars, presenting them as a low-emission alternative to petrol vehicles.
Of course, it would later turn out to be $77m poorly spent. After an investigation, the environmental protection agency revealed that Volkswagen had been installing a so-called ‘cheat device’ to detect when a vehicle was being tested and to improve its environmental performance accordingly. When in use on the road, the engines concerned were emitting up to 40 times the permitted level of nitrogen oxide.
It’s one of the most egregious examples of greenwashing and it landed the company with fines and compensation bills running into the billions. But it hasn’t stopped plenty of other companies from engaging in the practice.
Indeed, according to the international consumer protection and enforcement network, as many as 40% of websites globally are still making misleading statements about companies’ environmental credentials, whether that’s via omitted information or unsubstantiated claims. It’s a problem for consumers, who may want to reduce their carbon footprint, and for investors, who are increasingly taking a company’s environmental, social and governance (ESG) performance into account.
Ken Pucker is a lecturer at Tufts University and an author focusing on the efficacy of various sustainability efforts. As he notes, this ongoing greenwashing problem is a generational affair. “Assets are shifting from boomers and Gen X to millennials, and from men to women. These new stewards of wealth are more concerned with planetary welfare and the impacts of their spending and investing than their elders were,” he explains.
“This has created a demand for more sustainable enterprises. Then, during the 2010s, a few key research studies pointed to the possibility that high-ESG companies deliver better investment returns. This was a reversal from the previous prevailing wisdom on Wall Street, and it enabled the asset management community to sell ESG funds comprised, supposedly, of high-ESG companies to an increasingly interested investor audience.”
This is where ESG rating agencies come in. These firms rate companies based on their ESG policies and activities, gleaning information from a range of sources including company publications, government data and media reports. Unfortunately, this information often leaves a lot to be desired.
“When I see BMW telling me they’ve polluted a certain amount in scope 1 emissions, I don’t know if that’s good or not,” says Florian Berg, a research associate focusing on sustainable investing at the MIT Sloan School of Management. “Even if you compare it with other carmakers, I don’t know if it’s good or not because I don’t know how much BMW outsources to other companies. I need the ESG rater to tell me, to make the two things comparable.”
To get a better sense of a company’s genuine environmental footprint, you’ll need to know about its scope 3 emissions, which includes those emissions generated by partners up and down the supply chain. This is often the most significant category of emissions but is routinely omitted by companies attempting to improve their ESG scores. It’s just one of several greenwashing tricks in play.
“Coca-Cola set a target to become water-neutral by 2020. They achieved their goal five years early. However, they were the ones that chose how to define water neutrality; they defined it as water used within the four walls of their production facilities,” says Pucker. “That definition excluded more than 90% of the water that is needed to produce their end product, most of which is used in growing the agricultural products – mostly sugar – to sweeten Coke.”
Naturally, ESG rating agencies aim to take everything into account to give a more accurate picture of an organisation’s performance. But this doesn’t mean that ESG ratings can be relied on as gospel. MIT Sloan’s Aggregate Confusion Project, which has set out to improve the quality of ESG measurement and decision-making in the financial sector, has found that the correlation between ratings from different ESG agencies averages just 0.61. By comparison, credit ratings from Moody’s and Standard & Poor’s are correlated at 0.92.
To deal with this, efforts are now underway to make ESG ratings more objective. Many agencies are using AI or neurolinguistic programming (NLP) to analyse corporate data and reports. According to Berg, however, this must be handled with care. “The problem is that when you run an NLP algorithm on a sustainability report which has been written not only by the company but also by an adviser who knows exactly how to write these reports, I don’t see the NLP being good at figuring out how good or bad the company is,” he says.
“Where AI can be very good is filtering stuff for analysis. For example, you get hundreds of millions of news articles written every day and you can’t go through them all. AI can, though, so you can get down to a very small selection and then go through those by hand.”
National and international bodies are also moving to tackle greenwashing, although these efforts are mainly in their early stages. This summer, the EU finalised a deal which would require large companies to disclose their ESG risks and opportunities, as well as the impact of their activities on the environment and people – all of which would be externally audited.
In the UK, meanwhile, the new green technical advisory group is to oversee the government’s delivery of a green taxonomy – a common framework setting the bar for investments classed as environmentally sustainable.
For Pucker, though, it’s important not to fall for another type of greenwashing here: confusing reporting for real action. “Many of the known environmental challenges have accelerated, and it’s time to try a different approach,” he says. “I suggest changing the rules and incentives: regulate to help raise the floor and make companies internalise the external risks.”