The strong growth in the demand for ESG investment (integration of environmental, social and governance factors in the investment process) during the past year has made this type of investment acquire a more permanent meaning when choosing an investment product. investment, such as a fund.
But it is not easy for the manager to identify the companies that have really committed to being sustainable in their daily operations. Sometimes, the commitments remain in good words, without progress results being presented over time, in what is known as greenwashing, an English term used to refer to those companies that present themselves as sustainable and respectful of the environment. environment and human rights, among other factors, but in reality they are not. How can we better identify greenwashing and help reinforce the growing sense of responsibility towards ESG standards?
In a landmark ruling against Royal Dutch Shell on May 26, in the so-called Milieudefensie case, a Dutch court ruled that global climate policy applied under Dutch national law. Shell must demonstrably reduce its CO2 emissions by 45% by 2030 or the company will be found to be violating human rights.
This ruling came after Shell made a public commitment to operate in a more environmentally friendly manner. As early as 2018, it began linking executive pay to reducing their carbon footprint. More recently, under pressure from stakeholders and activists, it announced its plans to reduce carbon emissions and reach net zero by 2050. In this case, therefore, although commitments have been made and some steps have been taken, can it be said that Shell has been greenwashing?
The reality is that many shades of green can be considered when it comes to greenwashing. Like other global companies, Shell has sustainability strategies that it discloses publicly. But, in this new era of stakeholder capitalism, companies cannot simply commit with words, they need to show their commitment to sustainability with deeds. In this specific case, what could be penalized is the lack of clarity in the information and the urgency in establishing specific deadlines to fulfill the actions that were promised. The Dutch court ruling showed that just saying you are on the right track is no longer enough. Before the Shell case, greenwashing didn't seem to matter enough to fix it. But the last year we have seen a massive adoption of ESG (environmental, social and governance) factors around the world. Regulators with the new rules on ESG disclosure, big asset managers like BlackRock publicly committing to ESG, and millennials (more naturally inclined to embrace all things sustainable) started pouring into management positions. Everything points to corporate leadership taking on ESG and actually incorporating material ESG risks and opportunities into their businesses.
So, how to identify greenwashing (literally green washing)? There are several distinguishing characteristics of companies that truly strive to meet ESG criteria. In these companies, ESG is strategic, with the board of directors and senior management taking responsibility for the material risks and opportunities of ESG. These are companies where ESG is integrated into board strategy, risk, reporting and oversight, taking a data-driven, digitally-enabled approach.
Another characteristic that indicates the company's commitment is that the budget allocated to ESG is rich in cash, being allocated to activities that improve the business model. The level of business commitment to which ESG is included in the audited financial information is also noted, with processes in place to determine the material risks and opportunities of ESG. Furthermore, the ESG commitment is made specific, with companies explaining which issues are most important and why and where they are in the value chain.
The Dutch court in the Shell case was the first, but it will not be the last, for lawmakers to uphold global policies and hold corporations accountable for their actions. This year, the US Securities and Exchange Commission (SEC) clarified what the climate-related risks are and how they are affecting companies and investors. It also created a working group on climate and ESG to identify climate-related misconduct and now has authority to seek legal recourse if companies mislabel ESG funds and fail to improve their disclosures.
Regulators will continue to push for corporate leadership, but legislators are not the only group responsible for keeping greenwashing at bay. Other groups can help limit greenwashing. One of them is the public, demanding that companies clarify their history and strategy. Fortunately, the divide between corporate and consumer facilities has ceased to exist with social media, which enables direct engagement.
Of course also the media. When it comes to ESG, companies need to realize that if they don't provide a clear and consistent story, the media, as well as the public, will write it for them. And, of course, investors, who are reallocating capital to future-proof companies. Either through divestment, exclusion, or through their commitment as shareholders of companies on specific issues.
In short, it is always based on the quality of the information produced by the broadcasting companies. If it is bad from the start, then the ability of any group or stakeholder to influence becomes meaningless.
Paula Mercado is Director of Analysis at VDOS
