Unregulated 'greenwashing'? ESG investing is under the microscope as the money rolls in

Key Points
  • The coronavirus pandemic has shone yet more light on how investors allocate their money and how company operations influence our societies.
  • But there are questions about whether ESG is really effective in improving and supporting our communities. 
  • A portfolio manager told CNBC that companies can "hide" their actual carbon footprint by outsourcing parts of their production process.
Is sustainable investing just a marketing ploy?
Is sustainable investing just a marketing ploy?

LONDON — There's growing appetite to invest in a more sustainable way, but experts warn that transparency is needed in this space if it's to really do any good for the planet.

ESG (environmental, social and corporate governance) describes investments made with an aim to contribute to a better environment, society or workplace and it's becoming increasingly popular. The share of global investors that have applied ESG criteria to at least a quarter of their total investments has jumped from 48% in 2017 to 75% in 2019, according to data from audit firm Deloitte.

And this is only expected to keep rising.

In the U.S. alone, professional investors could have 50% of their total investments in ESG assets in the next five years, data from Deloitte also showed.

"There is this increasing understanding in society that we need to care about the climate, about social conditions of employees," Zacharias Sautner, a professor of finance at the Frankfurt School of Finance & Management, told CNBC last month via Zoom, adding that this is being reflected in the way investments are made.

The coronavirus pandemic has shone yet more light on how investors allocate their money and how company operations influence our societies. For instance, a number of multinationals have announced in recent months new measures to ensure a more equal workplace. 

But there are question marks on whether ESG is really effective in improving and supporting our communities. 

The challenges

"We have seen a booming of the number of, for example, ESG rating and scoring providers and that is an area which is largely unregulated and it is difficult for us to make sense of the different scorings and ratings if there is no clarity on the underlying methodology," Alessandro d'Eri, a senior policy officer at the European financial watchdog ESMA, told CNBC. 

He added that there's another issue which is "the mismatch between the expectations of investors in wanting more and more to invest in ESG type of products and the actual availability of products that are truly ESG compliant or sustainable."

This is the biggest challenge facing sustainable investing: there is no clear-cut criteria about what makes a company ESG investable.

For instance, one fund manager could argue that a company is not ESG-friendly and doesn't invest accordingly, while another portfolio chief might say the same firm is following sustainable criteria.

"When you think about the composition of ESG funds it's first of all important to remember they are still meant to be a fund invested to get a return for the portfolio. And so they can tilt based on industry groups, based on sector views and that may or may not relate to an ESG view," Sheila Patel, chairman of Goldman Sachs Asset Management, told CNBC.

This is evident when looking at the composition of some ESG funds.

The largest ESG fund in the world by assets, according to Refinitiv data from September, is the MFS Value Fund. It had 2.45% of its total portfolio allocated to oil exploration firms in July of this year. Ten years before that, 11.66% of its total fund was invested in these oil firms.

"That is another reason why we so definitely need the data quality," Dora Blanchet, team leader at the European Securities and Markets Authority, told CNBC.

"As long as you don't have robust methodologies there is no policing of what is qualifying as ESG investment," she added.

There are similar questions when it comes to tech giants. 

The fourth largest ESG fund under assets, Parnassus, had 17.26% of shares in companies such as Apple, Alphabet and Amazon.

However, the e-retailer Amazon, for example, registered a carbon footprint of 51.17 million metric tons of carbon dioxide last year — a 15% annual increase.

But some portfolio managers argue that Amazon's commitment to reduce its carbon emissions and become carbon neutral by 2040 is a reason why the stock is ESG-friendly.

One of the things we are very conscious of is when people or companies can very much hide their carbon footprint by outsourcing certain parts of their production process.
Christian Morgenstern
Portfolio Manager at IPM

"We could look at companies and say your carbon footprint today is not satisfactory. The old way that investors addressed that was often by taking their money out of those companies. Today divestment is not seen as the optimal way to push for change; engagement and stewardship by investing and asking for a clear timeline for improvements in things like carbon footprints is a much more, we will call it a 2.0 way of thinking about using capital in the ESG space," Sheila Patel, chairman of Goldman Sachs Asset Management, told CNBC.

The lack of clarity around ESG can make it difficult for those who want to support more sustainable businesses. 

"We look, at a company level, just about over a thousand different data points, and when I say a thousand different data points, this is what we really look for companies to publish. Now what we observe is that companies don't publish all of those data points and actually how much of their data is published in itself tells us a number of important insights into how companies implement ESG," Christian Morgenstern, portfolio manager at IPM, told CNBC.

One of the thousand data points he looks at is the carbon footprint of a company.

"Because one of the things we are very conscious of, is when people or companies can very much hide their carbon footprint by outsourcing certain parts of their production process to other companies or other jurisdictions and that in itself is not a good, not a good sign, not a good thing," Morgenstern  explained.

Regulation in the making

In this context, legislators and regulators have started stepping up.

The European Union has put forward a plan that from 2021 onward sets up performance thresholds and minimum safeguards that are meant to help investors and companies transitioning into a greener economy. This means by the end of next year, portfolio managers of ESG funds in Europe will have to explain how and to what extend they applied those safeguards when determining whether companies are following sustainable steps.

"We have largely seen the regulatory momentum taking place in Europe," Kristen Sullivan, partner and Americas region sustainability services leader at Deloitte, told CNBC, while adding there have been a few steps taken in the United States as well.

"I do think that U.S. companies, absent regulation, are not waiting. And I think companies certainly see that there are broader global trends, there's opportunity, this is not going to be just a compliance exercise," she said.

But experts agree that more oversight is needed.

"The degree to which companies provide true transparency on their ESG performance is not necessarily providing always useful information and that is a proxy of how or where the risk of 'greenwashing' may arise, because clearly companies claiming that are adopting an environmental policy but then it is difficult to assess the progress towards that policy," Alessandro d'Eri, from ESMA, said.

"Greenwashing" conveys the idea that a company or someone is providing misleading information about the impact of their activities in the environment.

"There is some room for creating some misconceptions," d'Eri added.