Author: Guido Bolliger, CIO
17 May 2023
Ajax washes whiter but ESG does not always wash greener (yet)!
ESG and sustainable finance markets are soaring and so are probes against asset managers for overstating their ESG practices. This overstatement is named greenwashing. It has caused some investors to question the ability of finance to contribute to the climate transition or, even worse, to turn away from sustainable products.
The economic roots of greenwashing
Apart from the financial interests of asset managers, there are two main reasons why greenwashing exists. First, there are no widely accepted standards yet in the financial industry for determining whether an investment is “green” or “brown”. Second, and most importantly, there are information asymmetries between asset managers and investors. Indeed, investors must rely on the asset manager’s voluntary and un-standardized sustainability disclosures. Therefore, investors can only view a product’s “greenness” through a glass darkly.
How do responsible investors invest?
We all know about the reported headlines and scandals (e.g. DWS) but there are not a lot of studies that focus on greenwashing in the asset management industry. However, there is a very interesting one recently published by Gibson, Glossner, Kruger, Matos, and Steffen , which investigates if institutional investors that sign the Principles for Responsible Investment (PRI) invest more responsibly than those that don’t. By 2022, the PRI network counts 5’319 signatories, representing $121 trn of AuM. By signing the PRI, investors commit to the adoption of the six PRI principles and to publicly report on their responsible investment practices on a yearly basis. The main conclusions from the study are:
- PRI signatories located outside of the US invest more responsibly (their portfolios have higher ESG ratings) than non-signatories. Furthermore, the ESG score of non-US located PRI signatories improve after they join.
- The average ESG ratings of portfolios managed by US located PRI signatories is at best identical to the ones of non-signatories. In other words, the average US located PRI signatory tends to greenwash.
- US located signatories that commit to PRI tend to do so after periods of under-performance. Hence, they may become signatories to countervail their subpar investment performance, while not deploying resources towards implementing ESG. The US PRI signatories with below-par ESG practices tend to serve the retail segment as opposed to the institutional clients, which are more sophisticated.
The authors advance many reasons for these differences between US and non-US located investors. Among them, conflicting ESG guidance in the U.S. regarding pension fund fiduciary duties depending on the political party in power. And a tighter regulatory scrutiny on ESG investing in Europe.
The good news for investors is that, on average, responsible asset managers located outside of the US stick to their commitments and invest responsibly.
Regulation and transparency are required
Regulation aimed at decreasing the information asymmetry between asset managers and investors as well as a clear and standardized definition of what can be considered as a “green” investment are essential to reduce greenwashing in the asset management industry. Despite the stammering that preceded their implementations, ESG regulations such as the EU Sustainable Finance Disclosure Regulation (SFDR) and alignment with EU Taxonomy will certainly help.
Investors should avoid throwing the baby out with the bathwater. Tighter regulation, increasing level of education among consultants and investors will allow to overcome greenwashing. In the meantime, investors may need to be more selective when investing in sustainable products. They can do so by focusing on SFDR 9 investment funds.
 I am purposedly using the word “average” because some of them don’t “greenwash”