Why ESG investors must look under the hood to protect against greenwashing
Following a year that saw severe weather wreak havoc on Canada’s supply chains and as COVID-19 continues to impact Canadians’ health and work, corporations and investors are diverting serious dollars toward environmental, social and governance (ESG) initiatives -- and securities regulators are taking notice.
“There’s this massive groundswell of investment into the space,” said Sarah Keyes, CEO of ESG Global Advisors. “It’s moved quickly, and it’s become like a wild west.”
According to the Responsible Investment Association (RIA), the value of “sustainable funds” in Canada reached $18 billion at the end of the first quarter in 2021, representing a 160 per cent increase from 2020.
ESG investing has become mainstream and concern over “greenwashing” – when a fund’s disclosure or marketing can intentionally or inadvertently mislead investors about the ESG-related aspects of a fund – has prompted the Canadian Securities Administrators (CSA) to publish guidance for fund managers on their disclosure practices. They are to include specifics such as the fund’s name, type, strategy, proxy voting procedures, risks, sales communications and terminology.
“The challenge with guidance though, is that it’s only guidance,” said Keyes who advises institutional and retail investors on ESG reporting. She warns that while the CSA guidance may help fund managers improve disclosures, it does not impose new obligations and is not enforceable.
Dan Chacko, director of sustainable investing and strategy with Montreal-based impact investment firm Clear Skies Investment Management, said investors struggle in selecting the right framework to measure non-financial performance, so they often rely on ESG scores derived by third parties like MSCI, Sustainalytics, and S&P.
“Analysts scrape through 10-K filings, corporate social responsibility reports, and [company conference calls] and convert them into datasets which are input to their own algorithms or methodologies and sold to investors,” he said. “These scores and the math behind them need to be understood.”
Clear Skies, which is launching a climate action fund with the objective of reaching $100 million in assets under management by the end of the year, invests in some private companies that may not have a dedicated sustainability team, ESG scores, or audited financials; so it has developed 180 of its own key performance indicators to assess its portfolios using the United Nations’ 17 Sustainable Development Goals as a framework.
There is also concern that the lack of a global set of standards for ESG investing is creating a knowledge gap among advisers and putting clients at risk. A recent RIA Survey indicated that while 84 per cent of financial advisers identify environmental matters as a top investment concern among their clients, only six per cent of advisers who participated correctly answered questions on responsible investing. Furthermore, 81 per cent of advisers expressed concerns about greenwashing.
“Before investors would just screen out companies like tobacco, put them on exclusionary lists and call this responsible investing,” said Chacko. “But now, investors want more because their clients want more.”
While the investor community welcomes more scrutiny of ESG disclosure practices, the CSA’s guidance leaves room for interpretation. Environmental metrics may be quantifiable, but measuring social and governance performance continues to baffle investors like Tom Rand, managing director of ArcTern Ventures.
“Whether you have a diverse looking board or provide training to your staff is a very different thing than if you’re eliminating emissions from your smokestacks,” he said. “[Regulation] is a great start because we all want to be good people, but I think it can be a distraction from getting on with the hard work of actually doing good in the world.”
Amber Fairbanks, a portfolio manager with Mirova Investment Managers (an affiliate of Natixis Investment Management), agrees it’s incumbent on investors to look under the hood and identify the real risks and opportunities when evaluating a company or ESG-related fund.
Her top ESG picks include Ørsted AS, a Danish firm that transformed from oil and gas to a wind utility company; Ball Corp., which manufacturers aluminum cans to replace single-use plastics; and Thermo Fisher Scientific Inc., which scaled production of COVID-19 test kits and manufactures lab equipment for cancer research and genomics.
“Not everything that has a number or checkbox is valuable to investors,” Fairbanks said. “A bank touting that their water usage is low is not material.”
Keyes said she believes more regulation is on the way and reminds investors of the Paris Agreement and Canada’s commitment to cut greenhouse gas emissions 40-to-45 per cent below 2005 levels by 2030. “The push for disclosure is only going to accelerate because we’ve only got eight years left to change course,” she said.