Investing in an ESG fund? Look for greenwashing risks in its disclosures

With awareness about the impact of human behaviour on the environment growing, the role a corporation plays in society and how it conducts its business have come under the scanner. Conscientious investors want to invest in companies that will help sustain the environment rather than harm it.

To this end, investors have been keen to allocate their money to funds that have shown a sense of responsibility in terms of the portfolio choices made by their investment managers. However, there have been issues with the way some investment funds operate, including in the ways their so-called Environment Social Governance (ESG) schemes are named and marketed to clients. One way in which this problematic behaviour manifests itself is “Greenwashing”.

Greenwashing in investment funds

Greenwashing is the act of an entity misrepresenting and making false or misleading statements about the environmental benefits of a product or a service it offers. There is always a danger that investment funds may market themselves as ‘champions of environment protection’ while not changing much in terms of how they invest.

In a report published in September 2023, titled ‘An Exploration of Greenwashing Risks in Investment Fund Disclosures: An Investor Perspective’, the CFA Institute has highlighted that comprehension of the sustainability characteristics of a fund can be challenging because of a number of issues. Those issues include inconsistent disclosures, omissions of key information regarding the sustainability goals or strategy, unsubstantiated claims, or undue emphasis on certain features that could appear to exaggerate the actual sustainability characteristics.

The report found that:

a) There are instances where ESG-related information would likely confuse an investor and may create a perception of Greenwashing

b) Greenwashing is difficult to uncover exclusively based on documentation and the analysis requires judgment

c) The context-specific nature of Greenwashing makes it difficult for investors to obtain a clear picture of how ESG factors are incorporated into the investment process and objectives of an investment fund.

Robust regulatory involvement

Regulators worldwide are now addressing the issue. For example, in the US, the Securities and Exchange Commission has proposed rules for enhanced disclosures by investment advisers and investment companies about ESG investment practices.

The Commission’s efforts to improve the quality and consistency of ESG-related disclosures from investment firms was a step in the right direction to ensure that investors do not get misguided by false and exaggerated claims.

In India, the problem is being addressed by regulators at two levels. For companies, BRSR (Business Responsibility and Sustainability Reporting) disclosures have now become mandatory for the top 1,000 entities by market capitalisation. The Securities and Exchange Board of India (SEBI) has also updated the BRSR reporting format. The BRSR is a standardized format for companies to report their performance on ESG parameters.

In July 2023, SEBI notified the rules relating to a new category of mutual fund schemes for ESG investing and related disclosures by them. The regulator’s disclosure requirements for ESG Schemes are as follows:

a) Mutual funds shall clearly disclose the name of the ESG strategy in the label of the ESG fund.

b) Mutual funds shall disclose the security-wise BRSR core scores (BRSR core is a subset of BRSR) and name of the ESE rating providers providing scores for their ESG schemes, in their monthly portfolio statements.

There are also changes planned as companies work on providing assurances about the validity of their BRSR data. For example, ESG schemes are mandated to invest only in companies that are in full compliance with BRSR disclosure standards. However, with effect from October 1, an ESG scheme will also be required to invest at least 65% of its AUM in companies that have comprehensive BRSR and BRSR core disclosures.

Onus on investors

There have been many instances of confusing, ambiguous, and incomplete disclosures related to green fund names, their goals, screening criteria, and impact claims. Greenwashing is a complex issue with several layers.

Hence, in addition to regulatory changes, investment managers have to carry out structured and thorough due diligence to ensure that the sustainability credentials of their fund are fairly represented.

From an investor’s perspective, an investment choice is a subjective and personal decision driven by individual preferences. The world faces myriad challenges today, including climate change, social/economic inequality, uncertainty and volatility in the global economy. Broadly speaking, considering these challenges and the need for accurate information devoid of any misrepresentation, it is a good idea for investors to become more aware about the various avenues available for responsible investment.

When investors are better informed about their ESG-based investment portfolio, it will improve the quality of their decisions. It is therefore important for them to look beyond labels and assess the investment philosophy and portfolio construction of ESG funds. They should also look at disclosure standards to assess if they feel comfortable with the information disclosed by the ESG fund, and see if it aligns with what they want to achieve.