An Exploration of Greenwashing Risks in Investment Fund Disclosures

Nicole Gehrig discusses concerns about greenwashing in the investment management industry and recommendations to address problematic disclosures.

As the Financial Services Development Council (FSDC) works on making Hong Kong a top international financial centre for green finance in the region, integrating environmental, social, and governance (ESG) factors has taken on immense importance. However, the incidence of greenwashing has created a risk in the investment management industry that investor outflows could result if the market loses confidence in green bonds and other green asset classes.

In a 2020 CFA Institute member survey, 78% of investment professional respondents globally believed there was a need for improved standards around ESG products to diminish greenwashing. In 2021, the Schroders Institutional Investors Study found that 59% of institutional investors identified greenwashing as a challenge in the ESG investment process. Moreover, public awareness of greenwashing has increased due to regulatory enforcement actions and skepticism about corporate climate commitments.

In response to the risk of greenwashing behaviors, the Hong Kong Stock Exchange has recently published a consultation paper on the enhancement of climate disclosure under its ESG framework. The paper suggested mandating all issuers to make climate-related disclosures in their ESG reports, and introducing new climate-related disclosures aligned with the International Sustainability Standards Board (ISSB) Climate Standard. This highlights the importance to local authorities of combating greenwashing and the need to evolve local regulatory requirements accordingly.

To further address the issue of greenwashing, CFA Institute published a report titled “An Exploration of Greenwashing Risks in Investment Fund Disclosures: An Investor Perspective”, that analyzes investment funds’ ESG-related disclosure information through the lens of investors to understand the nature of disclosure issues that could give rise to a perception of greenwashing. It analyzed product disclosures for a sample of 60 investment funds that are marketed to retail investors and that incorporate ESG factors in the investment process, with 30 funds from the European Union and 30 funds from North America.

Types of problematic disclosures

From the sample studied in the CFA Institute report, 10% of North American funds and 7% of EU funds exhibited problematic disclosures, encompassing inconsistencies between fund documents, omissions of information or unsubstantiated claims, and exaggeration (over-statement of or over-emphasis of certain ESG characteristics).

Inconsistency of disclosures was the primary issue encountered. For instance, one EU-domiciled fund disclosed in its sustainability policy an exclusion related to palm oil, however this exclusion was not listed in the prospectus. Conversely, the same fund had a nuclear energy exclusion listed in its prospectus which was not mentioned in the fund’s sustainability policy.

Another inconsistency found between the sustainability policy and the prospectus related to investments in companies that derive revenue from thermal coal. The sustainability policy for the fund stated a revenue threshold of 10% for company revenue derived from thermal coal whereas the prospectus noted a revenue threshold of 20% for company revenue derived from coal power production. In this case, the inconsistent terminology and threshold percentages would likely confuse an investor over the fund’s true exclusion criteria and sustainability policy.

Greenwashing is difficult to uncover and prove based on documentation alone

Greenwashing is difficult to uncover and requires a thorough review of product disclosures to make a judgment as to whether a fund is presenting its sustainability characteristics fairly. It is difficult to determine intent when problematic disclosures are identified, and individual investors might have different conclusions as to whether they felt misled.

Investors typically do not have access to the internal records, nor do they have the resources such as third-party research/raw data that they would need to analyse, review, and determine whether a fund is not doing what it says it will do. While regulators are the main actors with a view into the prevalence of greenwashing, their examinations remain confidential. This leaves investors with limited information with which to ascertain the true sustainability characteristics of funds with problematic disclosures.

Concerns about greenwashing are likely to persist until the quality of disclosures improves. To avoid the risk of a potential violation, firms can proactively try to improve the quality of their disclosures.

Recommendations to address problematic disclosures

For firms, it is important to prioritize strategies that mitigate potential violations through a focus on fair representation and the enhancement of disclosure quality. Firms should ensure that any utilization of ESG-related terms in fund names is directly aligned with the objectives, strategies, or policies they represent.

Consistency in screening criteria across different contexts is also critical, as it fosters transparency and minimizes discrepancies. Transparent reporting, disclosing the reasoning behind instances necessitating reporting, explains decision-making processes. Establishing precise definitions for ESG-related terms and metrics is another important step, contributing to clarity and reducing ambiguity.

For investors, it is crucial not to solely rely on marketing materials. It is advisable to thoroughly examine the fund’s offering documents and take time to review any available sustainability reports. Additionally, reviewing the fund’s impact report or other methodology reports can provide valuable insights into how the fund’s impact is measured, monitored, and reported.

While asset managers play a pivotal role in ensuring the integrity of sustainable investments, it is highly recommended that they prioritize full disclosure and fair representation of the fund’s sustainability claims or objectives. Caution should be exercised when making claims about the real-world impact of investments. Clear and substantiated evidence should accompany such claims to avoid any misrepresentation or misunderstanding.

Regulators can provide additional clarification and guidance to assist asset managers in the creation and promotion of their sustainable funds. A collaborative effort is required to harmonize terms and definitions related to sustainable investing across different jurisdictions.

Extending insights – a global imperative

As global interest in sustainable investing continues to rise, the potential for misleading practices that undermine the integrity of sustainability claims also grows. The insights gleaned from the exploration of greenwashing risks in investment fund disclosures underscore the need for concerted efforts from various stakeholders to address this challenge and ensure the credibility and effectiveness of sustainable investing.

While the scope of this analysis was limited to North American and EU markets, the principles and lessons discussed in this paper are universally applicable. Greenwashing is not confined to specific regions and can be observed in various markets where ESG investment products are offered.

As the world moves towards a more sustainable future, it becomes imperative to extend these insights to other markets and regions as well, fostering a global commitment to transparent and authentic sustainable investment practices.

By Nicole Gehrig, Director, Global Industry Standards, CFA Institute.

To Top
Share via
Copy link
Powered by Social Snap