By Edward Ding
Sustainability, ESG, GBPs. What do any of these things actually mean? Before we can get into a discussion about financial greenwashing, we first need to understand the meaning of “green” and a few other ideas.
Our first definition is of principles related to ESG: Environmental, Social, and Governance. “Environmental” refers to how a business affects the world’s natural resources, especially in terms of climate change; “Social” refers to a business’ relationship to the communities and people that it serves, employs, or coexists with; “Governance” refers to the way a business regulates itself, prevents wrongdoing, and ensures ethical corporate behavior. Businesses must act responsibly in all three of these areas if they aim to be sustainable organizations: to be sustainable is to run your business without compromising the wellbeing of future generations.
In the finance industry, “green,” in the broadest sense, is simply a loose synonym for the “E” in “ESG”; to be “green” means to be an environmentally responsible business. Of course, “environmentally responsible” is a vague description that can only be refined through precise guidelines; this is where the broad principles can be narrowed into stringent regulations.
The strict (or not-so-strict) definition of greenness varies across different financial sectors. In the public debt markets, for example, greenness is explicitly regulated by the International Capital Market Association (ICMA). For a debt security to be considered green, it must adhere to the ICMA’s Green Bond Principles (GBPs), which dictate how a security’s proceeds can be used, how the use of proceeds must be managed, and how the entire capital raise process must be reported. On the other hand, equity markets allow for a lot more leeway in defining green investments. An exchange-traded fund (ETF) could be legitimately marketed as a green fund for a number of different reasons: the fund might have undergone so-called ESG quality reviews, as claimed by one Bank of New York Mellon fund, or it might otherwise adhere to some third-party ESG metrics (e.g., avoiding investments in fossil fuel companies). What exactly makes a fund green is ultimately up to the fund manager. As described by Investopedia, “there are no strict rules regarding which companies or investment instruments are officially green.”
In the same way that financial greenness can be an imprecise term, the notion of greenwashing is also a fairly vague concept. In the broadest sense, to greenwash an investment or company means to present it as being green when it in fact isn’t. The specifics of this problem become clearer when regulators step in, as they have in recent months.
In May of this year, the US Securities and Exchange Commission alleged that BNY Mellon had misrepresented the greenness of some of its mutual funds; the bank itself was forced to pay a fine as penalty. The SEC has also been investigating Goldman Sachs for similar reasons, having expressed concerns that the firm’s funds haven’t met the ESG criteria that they claim to adhere to. The crackdown on greenwashing is part of a wider ramp-up in SEC activity under Chairman Gary Gensler. Gensler has been described as promoting “the SEC’s most aggressive agenda in decades.” Given this increasingly active regulatory environment, additional scrutiny of ESG and financial greenness is likely to come.
Naturally, the problem of greenwashing raises questions about green investing and green finance in general. So far, the SEC appears to be focusing on those funds and companies who have failed to meet their own ESG standards; said standards continue to be variant and somewhat amorphous, at least in equity markets. With so many definitions of greenness floating around, can it be said that any one of them is most effective in terms of what greenness is meant to achieve? In other words, which of these green standards is ultimately best at preventing climate change, at preserving the natural environment for the benefit of future generations? Even if a uniform standard is enforced in equity markets, as the ICMA principles are in the debt market, could that standard prove to be overly lenient and ineffective? These, of course, are all questions that regulators, investors, and companies will need to answer in the near future.