When it comes to sustainable finance, we’re still on the frontier of the Wild West. It’s a place of untold potential, romance, chaos and the vast unknown. As the climate crisis unfolds, interest from investors in this fertile ground is reaching fever pitch. Yet the current green rush has the potential to turn into a monumental greenwash unless it’s tamed soon. Luckily help is at hand.
“To be sustainable, we need to define sustainable,” says Adam Matthews, director of engagement at the Church of England Pensions Board, and therein lies the crux of the issue. There are certainly more than 50 shades of green finance, wrapped up in buzzwords, glossy brochures, soft-focus images and claims that a product is ethical. But it can be fool’s gold.
For instance, there is a low-carbon fund which includes holdings in companies that own some of the largest coal and oil reserves on the planet.
“One company we analysed advertised an ethical portfolio when 96 per cent of its assets were in UK government bonds; just 3 per cent were in an ethical fund. This is not a one-off case either,” warns Barnaby Barker, investment analyst at SCM Direct.
“Unfortunately, the regulator, the Financial Conduct Authority, is repeatedly failing to heed the warning signs of what could turn out to be the next huge mis-selling scandal.”
In the wake of greenwash comes “impact wash”, a new tendency for funds to label anything they do as contributing to the United Nations’ Sustainable Development Goals. “When in fact there are really no new or additional positive environmental or social impacts about the way they’ve allocated their capital,” says Narina Mnatsakanian, director of responsible investment at Kempen.
No green gold standard yet
This sustainable financial quagmire is bogged down by a lack of quality data and benchmarking, as well as transparency. “The industry lacks a consistent set of global standards for green investments. Investors cannot make assumptions about what companies may be included in products labelled as ESG [environmental, social and governance], sustainable or low carbon,” says Lihuan Zhou, associate with the Sustainable Finance Centre at the World Resources Institute.
With green investments moving beyond its specialist niche, a tipping point is being reached. “Mainstream financial companies and regulators are now interested. This is driving improvements in ESG reporting and investing,” says Guillaume Emin, project manager for information services at the London Stock Exchange Group.
Reporting frameworks aimed at cutting through the green fog are springing into action. For example, there’s the European Union Action Plan on Sustainable Finance, with Europe hoping its gold green standard will take hold in the coming months. Then there’s the International Platform on Sustainable Finance and the Task Force on Climate-related Financial Disclosures all weighing in.
“Adoption of standardised disclosure principles will increase the number of viable investment projects, but it will also drive more green finance activity in the real economy,” says Daniel Klier, global head of sustainable finance at HSBC.
Regulation around improved disclosure will certainly cut through the opacity, that’s why the EU has launched the world’s first regulatory benchmark. “However, until ethical data is audited by a third party and scrutinised properly, investors will continue to be mis-sold investments,” says SCM Direct’s Barker.
Building trust and transparency in green investments
The most often-cited challenge is still the perception that integrating ESG criteria into the investment process is at the expense of returns. “This long-held assumption is now collapsing under the weight of academic and practitioner evidence,” says Michael Lewis, head of ESG thematic research at DWS.
“Green finance is giving investors the opportunity to support a transition to a more sustainable world. But we need to build trust and integrity in sustainable finance.”
The speed with which the sector has gained traction is also creating an information vacuum. “We’ve noticed a need for educational materials that help professionals gain a better understanding of certain themes. Sufficient knowledge is instrumental when cutting through the greenwash,” says Masja Zandbergen, head of sustainability integration at Robeco.
“The worst that can happen is we look back in ten years and realise we haven’t achieved anything sustainability-wise and we’ve also failed financially.”
We remain a long way from a market that correctly prices the systemic risk climate change poses to investments, but things are changing quickly. “Once companies are held to account, begin to act in a more transparent manner and are rewarded by attracting more investors, the more they and their peers will be incentivised to be better companies. It’s a win-win for everyone,” Barker concludes.
How to steer through the fog of green
1. What isn’t measured, isn’t known
Check how funds are reporting and calibrate change against claims being made. There are no universal standards or globalised regulations.
2. Transparency is everything
Don't look at the headlines, but rather at the fine print and the footnotes. If you are presented with jargon, get explanations. The devil is in the detail.
3. Be vigilant, suspicious and question everything
Companies can still disclose information that makes them look good and hide details which don’t. Impact-washing is everywhere.
4. Untruths on returns
There are still some who believe that environmental, social and governance (ESG) concerns come at the expense of investment returns. Research shows this is not true and in some cases ESG can enhance profits.
5. Continuous education
Times are changing rapidly and the market is evolving. You need to keep abreast of relevant themes. ESG is not an exact science and takes time to understand.