Why has ‘greenwashing’ become a serious problem?
Of concern is the scale and increasing frequency of discovery of these greenwashing activities amongst some of the largest firms, but also the extent to which these greenwashing activities impact the perception of firms in light of ESG investing.
For one, it is possible that the greenwashed data is sufficiently believable that it gets incorporated into the ESG score, which then distorts the core metric that individuals or the markets may use in their investment decision-making.
Moreover, such greenwashing information distortions can be visualised as ripples in that they can have an impact in areas far removed from its origins, thus creating misrepresentations of prices.
Imagine a company that has engaged in sufficiently sophisticated greenwashing activities that the ratings agencies have now decided to include that disinformation into the ESG rating. Investors would now purchase shares in said company based upon its ESG rating, resulting in an increase in its share price. Existing holders of said company’s shares will see increases in their own portfolios and net worth.
Now imagine that the investors are not just individuals like you and me but rather large institutions such as banks and corporations who themselves have issued shares. If their portfolios have increased in value because of their misrepresented ESG investments, then it is likely that this increase in net worth will result in a proportional rise in their own share prices -- all borne of the initial environmental disinformation.
What we then have is greenwashing being priced into financial assets, pulling prices further away from their “true” value. Put simply, it is possible that these greenwashing activities make a market more inefficient and that any corrections can have wider impacts in both the short- and medium-term.
This is concerning because the appetite for ESG or some notion of responsible investing is growing. Statistics published by the IMF highlight that ESG-linked borrowing more than tripled last year with ESG investments now making up almost 18% of foreign financing for emerging markets, excluding China. Moreover, data from financial services firm Morningstar also highlights the considerable growth in ESG funds with an estimated asset valuation of $2.7 trillion in 2021.
Given this increased activity within the ESG arena there are desires to ensure that the markets are free from any form of distortion, greenwashing or otherwise.
What can be done to combat greenwashing or similar practices?
Whilst there have been concerted efforts to minimise the effects of greenwashing on markets, what is unclear is the efficacy of such interventions.
For example, there have been numerous proposals for decentralised blockchain innovations that could help track the environmental credentials of firms. This would help minimise the opportunity to greenwash with greater informational scrutiny. However, such initiatives are young as yet and there is insufficient data to assess their effectiveness.
Moreover, there are also some concerns about the efficacy of ESG as a metric given what it is trying to capture. A review of ESG calculation methodologies reveals inherent complexity with numerous categories of data, multiple layers of informational sources, and hundreds of variables that go into the formulation of a single value. This complex matrix of data and information can lead to a greater number of points of failure in terms of greenwashing assessment.
To add to the trepidation of ESG is the lack of a consistent approach to calculation with different agencies adopting various methodologies, and there is no single universal standard for the reporting of ESG credentials. However, there have been attempts to address this lack of a foundational framework, for example, recent EU legislation aptly named the Sustainable Finance Disclosure Regulation that provides a standardised framework for ESG reporting. There are also similar policies being developed by the US Securities and Exchange Commission (SEC).
Story: Ngoc Hoang
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Thumbnail photo: thithawat - stock.adobe.com
