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Don’t feel brainwashed by greenwashing

Date: 31 March 2022

Who is this article for?

Advisers who want to understand what greenwashing is, how to spot it, and how to avoid it.

Key takeaways

If you’re concerned about ‘greenwashing’, you’re not alone; in fact, 65% of advisers have admitted to worrying about the wool being pulled over their eyes when it comes to advising their clients on ‘green’ or ‘sustainable’ investments.

This article will help you understand what greenwashing is and make sure you don’t fall foul of greenwashing when incorporating ESG into your advice for clients.

What is greenwashing?

The term might stir up images of minty fresh mouthwash, but when it comes to clean living, greenwashing is something entirely less wholesome.

In short, greenwashing can be defined as making unsubstantiated or misleading claims to deceive consumers about the sustainability characteristics and benefits of an investment product.

At company level, greenwashing can be done in a number of ways, for example by focusing on ‘green’ projects to create a false impression and detract attention away from less sustainable ventures, or by claiming an environmental benefit where none truly exists. At a fund level, greenwashing occurs when asset managers over-claim and over-sell what they are actually providing in terms of a responsible or sustainable investment.

It’s important to remember that environmental factors only make up the ‘E’ in ESG; it’s also essential that fund managers assess the social and governance factors of an underlying asset to avoid misleading investors. Instances of this have been seen in the press in recent years, where funds have invested in companies which later turn out to have a reliance on cheap labour in their supply chains or corrupt management teams.

Greenwashing in the advice and fund industry

For advisers, greenwashing causes two big problems. Firstly, it’s been proven to be a huge concern of clients when it comes to responsible investing, with 44% of investors saying investments not being what they claim to be is their biggest worry. For some clients with a strong ESG preference, this concern may be enough to put them off investing full stop.

Secondly, for advisers picking investment opportunities, the art of ensuring their client’s worst fear won’t indeed come true is extremely challenging, given the lack of standard disclosure across the fund industry, a lack of solid definitions around what’s classed as ‘green’, and a lack of consistency around the reporting of environmental factors.

Advisers also have the challenge of trying to measure the ESG credentials of the client themselves; in other words, a client may feel ‘greenwashed’ (or misled) by an investment that doesn’t live up to their expectations, whereas the true problem may lie in assessing their level of desire to be sustainable alongside their appetite for risk and reward, and then building a suitable portfolio to match. For that reason, it is advisable to conduct a strong client suitability assessment initially, to ensure you fully understand a client’s preferences in this area.

Regulation helping to combat greenwashing

With ESG-labelled funds on the rise, the FCA has committed to help solving the problem of greenwashing, undertaking a consultation on new sustainability disclosure requirements for asset managers and FCA-regulated asset owners, as well as a new classification and labelling system for sustainable investment products. This should help advisers match client preferences to an appropriate investment.

In addition, the Sustainable Finance Disclosure Regulation (SFDR) imposes mandatory ESG disclosure obligations for EU domiciled funds. SFDR Level 2, due to be adopted from January 2023, will introduce regulatory technical standards through which asset managers have to justify their fund categorisations through a series of both environmental and social principal adverse impact disclosures.

How can you make sure you don’t fall foul of greenwashing?

The upcoming regulations, when launched, will no doubt go some way to helping investment firms deliver the reliably sustainable investment products that investors want and enable advisers and clients make better informed choices.

In the meantime, there are several things you can do to ensure you don’t fall foul of greenwashing when selecting your clients’ investments:

  • To avoid greenwashing it’s vital that advisers conduct due diligence rather than relying on a label or a name. Doing the research and finding out how fund managers are investing responsibly, what they are holding and how this could make a difference will allow you to make an informed decision and give you the confidence to invest in a responsible manner.
  • To determine the true extent of a fund’s sustainable credentials, it’s important to take a wide view and assess the social and governance as well as the environmental impact.
  • Rigorous research will always be key to combat greenwashing, with advisers needing to find the right data points and ratings to meet the requirements of their end investors. Providers of responsible and sustainable investment solutions should provide clear objectives for these investments to help advisers understand if investments are appropriate for their clients. On an ongoing basis, they should provide comprehensive, transparent reporting on how investments are performing relative to these objectives so that advisers can ensure that investments remain suitable.
  • It is important to understand that sustainable funds vary in their approach and to bear in mind your client’s need (or not) for diversification to manage risk alongside their ESG preferences.
  • There is a balance to be struck between your client’s ESG preferences and the ability to diversify their investments. The greater their leaning towards sustainable investments, the more challenging it becomes to offer a fully diversified portfolio. It is important to understand how investment managers have sought to resolve this if you are considering using their solutions for your clients.

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