Environmental, Social, and corporate Governance (ESG) represents a set of standards (diversity and inclusion, gender pay gap, labor rights, climate change, etc.) used by investors to identify material risk and opportunities in their current portfolios and future investment decisions. This is because research shows “a positive relationship between corporate sustainability and financial performance.”
While ESG investing has become a hot topic worldwide, with more interest from investors than ever before in companies with solid sustainability initiatives, the lack of regulations has paved the way for greenwashing.
Defining ESG Greenwashing
Greenwashing means a company is engaging in marketing or public relations strategies to appear as if they are making a positive ESG impact. Instead of taking meaningful action against environmental, social, and governance issues, false claims are made about the sustainability of a company’s products and services.
Greenwashing can also be done by an organization or a financial services firm to promote certain funds. It can be difficult for investors to know which funds impact the environment positively and take the correct stance on social and governance issues.
ESG Greenwashing: A Top Challenge for Investors
According to Schroders Institutional Investor study, 59 percent of investors view greenwashing as their top challenge when selecting sustainable investments.
Identifying greenwashing is becoming more difficult as ESG investments become mainstream for portfolio companies and investors. There are many investment products labeled as sustainable, and there is no way of telling which are genuinely sustainable and which aren’t.
Lack of ESG Reporting Regulations
A key reason why greenwashing is so easy is due to the lack of regulations around ESG reporting. Currently, there are no set rules around ESG and sustainability initiatives, which makes it easier for companies to give a false impression and provide misleading information about their products and services. To prevent greenwashing, the European Union set a foundation with the Sustainable Finance Disclosure Regulation (SFDR) to establish a framework to facilitate sustainable investments.
In light of the EU Green Deal and to further sustainable finance initiatives, the EU created a taxonomy for sustainable activities which defines what can and cannot be classified as sustainable.
As the first of its kind in the ESG investing world, the EU SFDR sets the foundation for other countries in mandating ESG regulations; however, it does not directly apply to the U.S. financial market. Since the U.S. does not currently have regulations around ESG reporting, fund managers and investors must be aware of each company’s ESG actions and critically analyze the company’s approach to ESG.
Third-Party ESG Performance Measurement
Financial institutions, asset managers, and other stakeholders measure a company’s ESG performance through third-party data providers and rating agencies. Third-party data providers such as FactSet provide reports and ratings on international and domestic public and private companies on their ESG performance compared with peers.
Although ESG ratings can help identify companies with favorable ESG practices, they can also contribute to greenwashing. The report and ratings from providers can vary depending on each provider’s methodology towards scoring ESGs.
Rating providers range from independent firms like Sustainalytics to larger index providers like Bloomberg ESG Data Services, S&P Global, FTSE Russell, etc. Therefore, financial advisors and investors need to compare the reports and ratings of various providers.
Power of Analyzing Historical Data
It is easy for third-party providers and investment firms to find green stocks and bonds that have high ratings, but still may not accurately represent a company’s true ESG performance. It is far more challenging to dig down into what matters and requires data analysis over some time.
Another way to understand a company’s ESG practices is by analyzing historical data. Historical data shows how a company has practiced sustainability initiatives across the past several years, which can provide insight into how a company views sustainability, how long it has practiced sustainability, and whether its other actions align with its marketing campaigns.
Combining historical data with ratings can serve as a powerful strategy for investors to understand a company’s ESG actions. If the historical data matches with the ratings, that’s a strong indicator that a company is honest about its ESG and sustainability initiatives and isn’t trying to greenwash.
Due Diligence on Greenwashing
Investors and financial advisors can navigate against the risks associated with greenwashing by analyzing data and performing due diligence. They can do this by researching and evaluating the information companies provide on ESG-labeled products and services.
Additionally, since there are no standardized reporting requirements, investors and advisors can understand an organization’s ESG practices by seeing if the company uses a standardized framework to measure ESG performance and impact.
Organizations that provide an ESG framework include:
- The UN Sustainable Development Goals (SDGs) provide a defined framework for companies to follow with 17 SDGs and 169 associated targets on tackling poverty and ensuring more equality, environmental sustainability, and economic development.
- The Global Reporting Initiative is a global independent organization that helps governments and businesses understand the environmental, social, and governance issues and tackle them. The GRI Standards provide transparency on the impact of companies on sustainability issues.
- The World Benchmarking Alliance measures the impact of businesses using the SDGs.
- The Sustainability Accounting Standards Board (SASB) helps businesses identify, manage, and report on sustainability topics. It also allows investors determine the ESG issues that are most relevant to financial performance.
These organizations are committed to helping businesses, governments, and other organizations understand and communicate their impact on environmental, social, and governance issues such as climate change, human rights, and corruption.
Solutions for Identifying ESG Greenwashing
Identifying companies that are true to their ESG initiatives is challenging, primarily because of the lack of regulations around ESG ratings, the number of companies labeling their services and goods as sustainable, and greenwashing.
Although third-party providers are an option, it’s hard to tell which third-party provider has the most accurate ESG ratings.
Manual Analysis of Text Data
Investors and financial advisors can manually analyze company data and news; however, this is extremely labor intensive and may not accurately interpret all available information.
AI Solutions for Fast and Accurate Analysis of Text Data
The Accern NoCodeNLP Platform empowers financial advisors and investors to quickly research, extract, and analyze millions of unstructured data sets to understand a company’s ESG stance and performance.
Using the pre-assembled data sources – global news and public data and content from leading data providers including FactSet, Morningstar, Dow Jones, Naviga, and more – users can build ESG-focused NLP models with historical and real-time information.
With data on thousands of public and private companies and over 26 ESG events that come out-of-box including but not limited to fuel management, supply chain, employee health, safety, and wellbeing, labor relations, social impact, and business ethics, investors and financial firms can identify a company’s ESG practices by calculating accurate ESG sentiment scores.
Schedule a demo to learn more about the Accern NoCodeNLP Platform and how it can drive ESG-focused insights for your investment portfolio.