Investing in ESG financial products is all the rage these days. Making money while saving the planet – what’s not to like! Unfortunately, it comes with significant manipulation risk in the form of greenwashing. 

As Investopedia defines it, greenwashing “is the process of conveying a false impression or providing misleading information about how a company’s products are more environmentally sound.” The term dates back to the 1960s when hotels were accused of greenwashing by encouraging guests to reuse towels to save the environment. The hotels didn’t tell guests about the savings they enjoyed in reduced laundry costs.

Greenwashing can be used to describe any unsubstantiated claim to deceive consumers into believing a product is environmentally friendly. Lately, it has appeared in financial services, which is our focus here. Although the term can more broadly apply to false claims about a product being “natural”, “healthy”, “chemically free”, “recyclable”, or the like. 

In financial services, greenwashing is a major manipulation risk in the investment area of ESG. It’s an attempt to capitalize on growing demand for environmentally sound investment products. The problem? Not all of those products make money, so bad actors are tempted to greenwash their investment products, making them appear environmentally sound when they are anything but.

Greenwashing and ESG

ESG stands for Environmental, Social, and Governance. When companies or investment products represent themselves as “ESG” it means they adhere to a prescribed set of standards. Namely, they want you the investor or consumer to know they are socially conscious and screen potential investments to ensure they are environmentally sound. 

ESG financial products have appeared in the form of exchange-traded funds (ETFs), mutual funds, and even robo-advisor offerings. Marketers of these products often argue that overlooking ESG risks like climate change will have negative consequences on a company’s long term profitability and sustainability. They will point to incidents like the BP oil spill or the Volkswagen emissions scandal and argue that the financial consequences of these events can be avoided by investing with an ESG criteria. 

If someone promises an investment product that sounds too good to be true, it probably is. Just ask Bernie Madoff’s investors. Altruism and investing have rarely operated in unison throughout financial history. Capitalism rewards companies that supply quality products where there is strong demand. Leave your feelings at the door. 

The problem with many ESG financial products is that they are not quality. Many cannot keep pace with the broader market. An ESG company or investor may have missed oil’s stellar returns year to date. 

Assurances alone that you’re saving the planet do not pay the bills today. Isn’t that sort of policymaking best left to legislators instead of individual companies and investors anyways?

So what do financial services hucksters do when traditional ESG products don’t perform or sell? Greenwash. Regulators are just starting to catch on as illustrated in the recent cases involving BNY Mellon and Deutsche Bank. 

Greenwashing Oversight and Fines

Not every company sets out to intentionally mislead investors on its ESG claims. They may have simply overhyped them. Or accidentally omitted material points.

The SEC and other regulators have taken notice. And they need to. “Sustainable investing” accounted for 33% of total U.S. assets under management as of late 2020. People are throwing money into the space and potentially being misled. 

Which is why the SEC recently proposed two new rules for ESG fund disclosure. One is a “Names Rule.” Basically, 80% of your fund’s assets should be in whatever is in the fund’s name. So the ABC Clean Energy Fund should invest 80% of its assets in “clean energy.” 

Second is a rule focused on disclosures that would be required about a fund’s ESG strategy. An example from the announcement includes: 

Funds focused on the consideration of environmental factors generally would be required to disclose the greenhouse gas emissions associated with their portfolio investments. 

There are good arguments that these requirements could discourage ESG funds. The disclosures are onerous. But the SEC has to prevent behavior as exhibited in the recent BNY Mellon case, which the SEC announced just two days prior to publishing the proposed rules. 

In that case, BNY Mellon’s investment adviser business had represented or implied in various statements that “all investments in the funds” had undergone an ESG quality review. That was not always the case. The SEC Order found that “numerous investments held by certain funds did not have an ESG quality review score as of the time of the investment.”

The firm was fined $1.5 million. A slap on the wrist for a case that is a first of its kind. 

Greenwashing Raids

The BNY Mellon case was truly a first of its kind until Deutsche Bank’s German headquarters was raided about one week later to investigate similar greenwashing allegations. The allegations come from a whistleblower in the retail money management business, basically accusing Deutsche Bank of selling ESG investments under false claims. 

The whistleblower had previously held the title, “Head of Sustainability” at Deutsche Bank. She was quoted as stating the following:

“ESG is complex and still in its infancy, so it is understandable if fund managers lag behind. But it is quite another thing to deliberately provide false information. It is terrible when executives misuse this issue as a marketing tool.” 

Yikes. For what it’s worth, Deutsche Bank has denied the allegations. Regardless, we cannot ignore the risk that companies and funds greenwash and misuse the marketing power of ESG. As more money pours into the space and regulators continue to circle, these recent raids and fines are only the beginning.

A Green(washing) Future

No SEC rule or regulatory requirement will prevent founders from making unsubstantiated claims or playing on investing emotions. Just look at Elizabeth Holmes’ case. Or the case of the electric trucking company, Nikola.

Greenwashing is just the latest in a long line of fraud and manipulation cases in the financial services industry. The SEC and other global regulators are right to focus on some of the “green” claims that are being made. But they should be careful not to deter “green” innovation in financial services.

It is one thing to deter bad actors by making them disclose basic information about their company or fund. It is quite another to require intensive greenhouse gas calculations or other complex quantitative data points. If it becomes too costly or burdensome to become an ESG fund, asset managers simply won’t even try. 

In that case, instead of regulators promoting ESG, they would be facilitating assets moving away from what conceptually should be making the world a better place. While I still contend that ESG is mostly within the remit of legislators, encouraging socially responsible investing is not the worst thing in the world.

Regulation of greenwashing must balance those interests. Require basic disclosures without the unnecessary detail. Audit and examine companies and funds regularly to make sure they comply.

As with most newer forms of manipulation and fraud, greenwashing is really nothing new. It’s a deceptive strategy that employs old methods used to market the latest area in high demand.

Consumers and investors alike should scrutinize any product making bold ESG claims. Similarly, companies and funds should question their ESG claims and make sure they can substantiate their truthfulness.

Otherwise, instead of promoting a green future, they will all be washing it away.