A few years ago, I was fortunate enough to be invited to an event hosted by the Rothschild Foundation at the family’s estate at Waddesdon Manor.1 Wim Leereveld, the founder of the Access to Medicine Foundation, was taking questions from assembled guests. He was asked about the growing prevalence of ‘greenwashing2’ in the market for financial products and what should be done about it. His response was rather unexpected. He said – and I am paraphrasing – that he was reasonably relaxed about it. He saw it as evidence that there was real underlying demand for sustainable financial products. The market, he anticipated would quickly evolve to unmask any greenwashing.
If anything, this debate has now reached fever-pitch. Writing in USA Today in March, a former sustainability executive at Blackrock opined that ‘sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community’.3 Sustainable investing provides a smokescreen, he claimed, which actively impedes the required changes in regulation. The medicinal equivalent, as he put it, of wheatgrass to a patient suffering from cancer.
Frankly, a mainstream debate in the pages of USA Today certainly feels like progress. Until the last few years debates about greenwashing were confined to the rarefied atmosphere of foundation-convened gatherings at remote country estates. The FCA’s own definition of the issue only dates to 2019.4
Regulating sustainable finance
But with more than 250 European funds being rebadged as sustainable last year,5 greenwashing has become a problem requiring a more formal regulatory response. Readers will no doubt already be aware that regulators are responding. At the start of March, all investment funds available to European investors needed to declare how central sustainability is to their investment process. These Sustainable Finance Disclosure Rules (SFDR) allow for three levels of integration. Article 6 indicates limited ESG integration. Article 8 is for funds with some sustainability focus and Article 9 funds are those where sustainability is central. At WHEB we announced that our investment strategy will be considered an ‘Article 9’ strategy.6
Next up, asset management firms will need to disclose against the ‘EU Taxonomy’ which is intended to provide a definitive list of environmentally sustainable economic activities.7 By January 2022, investment funds available in the EU will need to disclose what proportion of investments are in areas covered by the Taxonomy. The current draft just covers climate change (both adaptation and mitigation) and is still to be finalized.8 The plan is that by next January other environmental objectives, such as the circular economy and pollution prevention and control, will be covered by additional taxonomies.
Given this uncertainty, most companies have not yet published their own assessments. Nonetheless, in advance of the January 2022 deadline, WHEB has made a preliminary assessment of the proportion of our investment portfolio that is likely to be eligible. Across the entire portfolio we estimate that between 12% and 36% of investments are likely to be taxonomy eligible. This represents 24-72% of total investments in our environmental themes. We would expect this number to increase as further environmental objectives are addressed in 2023, and as companies report their own assessments.
The European Commission has also begun to evaluate a potential ‘social taxonomy’ covering water and food, healthcare, housing and education among other areas. We would hope that much of our socially-themed investments would be eligible under this taxonomy.9
While we still have reservations about elements of the EU’s sustainable finance regulations,10 we hope they confront the more egregious examples of greenwashing. Certainly, initial analysis suggests that the SFDR has been effective in ensuring that fund managers are clearer about how central sustainability is to their investment processes. Preliminary analysis by Morningstar of over 5,000 funds found that less than 4% have self-certified as Article 9 funds. A further 18% are classified as Article 8. The remainder are classified as Article 6 funds.11
Market-based approaches
Alongside these rather directive interventions by the EU, the UK has supported a more market-oriented set of initiatives. Prominent among these is the work of the British Standards Institute (BSI). Utilising industry expertise (including from WHEB), government, academia as well as non-governmental organisations, the BSI has led the development of a suite of Publicly Available Specifications (PASs). So far these have covered the core principles of sustainable finance (PAS 7340) and the criteria for Responsible and sustainable investment management.12 The work of a third PAS focused on the fund level started in March 2021.
Regulation of the real economy
Regulatory and market-based efforts to delineate sustainable finance are a welcome and necessary response to the proliferation of greenwashing. Nonetheless, this finance-focused regulation should be a supporting act for better integration of sustainability imperatives into the real economy. Ultimately, the extent of investor and company action on sustainability are delineated by underlying economic regulations and signals. In a poll for Standard Chartered, 64% of 250 senior executives said that they ‘believe the economics of operating as a net zero organisation do not stack up for their company’.13 Some of these executives may not have fully explored the full range of options and strategies available to them, but the point remains. Investors and companies can only achieve so much within the current market paradigm.
Jorgen Randers, a Norwegian professor and co-author of the original ‘The Limits to Growth’ report, put it best in advice to BT back in 2003. His guidance for businesses (and investors) is to work within the existing market to ‘do the profitable thing… and do it as responsibly as possible’. But critically he said that at the same time businesses should push regulators and other stakeholders on a moral basis ‘to [make] more of those responsible things more profitable in the future’.14
The regulation of sustainable finance will, we hope, help with greenwashing. But rather than just limit what finance can claim to achieve, the better ambition is to support the change it seeks. More fundamental regulatory change in the real economy is still required to achieve sustainability, but Leereveld was right all those years ago. A very large number of people want their capital to be in some way impactful. It is of course right to protect them from shysters. It is just as important to give them more credible ways to achieve their goals. For too long environmental change has been held back by a lack of interested capital. Let’s not let this moment go to waste.
1 https://rothschildfoundation.org.uk/dialogues/
2 The FCA defines greenwashing as ‘marketing that portrays an organisation’s products, activities or policies as producing positive environmental outcomes when this is not the case’.
4 https://www.ftadviser.com/regulation/2019/10/16/fca-moves-to-protect-investors-from-greenwashing/
5 https://www.responsible-investor.com/articles/friday-funds-253-funds-rebadged-as-sustainable-in-2020
8 The final version is expected towards the end of April 2021.
11 https://www.investmentweek.co.uk/news/4029273/21-total-european-funds-most-stringent-sfdr-rules
12 PAS 7340 is freely available at https://shop.bsigroup.com/ProductDetail?pid=000000000030387840 and PAS7341 at https://shop.bsigroup.com/ProductDetail?pid=000000000030387841