confused man

As head of Canada’s Responsible Investment Association (RIA), I have been following media coverage of greenwashing very closely for the past few years. Prior to 2019, coverage of responsible investment (RI) was typically positive as pundits and readers welcomed asset managers’ efforts to incorporate environmental, social and governance (ESG) issues into investment decisions.

But the conversation changed in 2019 as assets piled into RI funds and observers dialled up the scrutiny. It is now commonplace to see articles and social media posts expressing concern about greenwashing, partly because scrutiny is a normal and healthy part of a maturing market, and partly because different people have different ideas about what “responsible” or “sustainable” investing means.

To complicate matters further, people have different ideas of what “greenwashing” even means. Case in point: defines greenwashing as “a superficial or insincere display of concern for the environment that is shown by an organization.”

On the other hand, Oxford defines greenwashing as “disinformation disseminated by an organization so as to present an environmentally responsible public image” (emphasis added). These definitions of greenwashing are materially different because disinformation — which is defined as false information that is spread to intentionally deceive an audience — is specified in one but not the other.

So, terminology is a huge issue. When different people are using the same words to mean different things, confusion and skepticism are likely to arise. We are seeing some of that play out in the market today.

Want more immediate, memorable insights? Listen to this Soundbites episode, featuring James Black of Beutel Goodman Investment Counsel.

It is worthwhile to note that the spreading of disinformation is a rare occurrence in Canada’s investment industry. Although there is no ESG-specific regulation in Canada, the industry is heavily regulated, and fund companies that engage in misleading sales or marketing practices risk facing penalties, regardless of whether a fund is marketed as ESG.

While there may be a small number of bad actors in the market, I would argue there are three much bigger factors contributing to rising concerns about greenwashing in the investment industry: complexity, subjectivity and fragmentation. Together, these factors combine to generate confusion and skepticism.

1. Complexity

RI is broadly defined by leading industry bodies – such as the Principles for Responsible Investment, Global Sustainable Investment Alliance and CFA Institute – as the incorporation of ESG factors into investment decisions. The terms “responsible” and “sustainable” are often used interchangeably, and the wording varies slightly from one definition to the next, but consideration of ESG factors is the key component.

RI is dynamic and complex because there are many different ways for asset managers to incorporate ESG factors into their investment processes. There is a tendency to incorrectly assume RI or ESG means screening or exclusions, but that is not necessarily the case. It’s important to understand that screening is just one approach to RI among many. The most prominent approaches are ESG integration, shareholder engagement, thematic investing, impact investing, negative or exclusionary screening, and positive or best-in-class screening. (See definitions here). Moreover, investment managers have different mandates and methods for implementing these approaches.

To be clear, responsible investing is not rocket science — a keen investment professional can learn the basic concepts in a few days. But, as shown in the data below, the leap is much bigger for non-investment professionals.

The Canadian Securities Administrators’ 2020 Investor Index survey of 5,000 Canadians found that 48% of respondents had “low knowledge” of investing, and only 20% demonstrated “high knowledge,” meaning they could understand basic concepts such as diversification and compound interest. So, general investment knowledge is low, which means knowledge of responsible investment is even lower. In fact, the RIA’s 2020 Investor Opinion Survey found that only 4% of 1,000 investor respondents reported that they knew “a lot” about RI.

With such low literacy, the dynamism and complexity of responsible investment can lead to confusion for many observers.

2. Subjectivity

Although industry bodies have defined responsible investment and the various approaches described above, words like “responsible” and “sustainable” can be subjective and open to interpretation. Many people have their own ideas about what these words mean, and that is particularly evident in dialogues around fossil fuels. For some, an RI fund should exclude oil and gas companies. For others, an RI fund should engage with oil and gas companies to promote environmental stewardship, since selling an oil stock does not change the demand for oil.

These two examples — exclusion and engagement — are both legitimate responsible investment strategies. Deciding between the two simply comes down to what the investor wants to achieve. (See my previous column for more on this topic).

It gets even more difficult with terms like “ethical investing” and “moral money,” since ethics and morals are inherently subjective. This subjectivity leads to confusion when people use the same words to mean different things

3. Fragmentation

In addition to complexity and subjectivity, there is also fragmentation, particularly with respect to ESG disclosures. There is currently no standardized disclosure framework for responsible investment funds to make ESG-related claims. The result is that it’s hard for advisors and investors to compare RI funds in a simple format.

The market needs standardization, and that means it also needs convergence. The industry needs to converge around common frameworks and common definitions. On this front, the CFA Institute is in the process of developing an ESG disclosure standard for investment products, which is scheduled to be released in November of this year. The Institute’s framework will play a vital role in promoting convergence in the industry.

However, the CFA Institute will stop short of creating a label or providing assurance that a fund has met certain criteria or performance thresholds. That is why the RIA is currently exploring a fund certification model that would leverage the CFA’s disclosure framework as an input, while also creating a label to show that a fund has met minimum ESG criteria. Together, the CFA’s global ESG disclosure framework and a Canadian RI fund certification could significantly reduce the fragmentation, complexity and subjectivity described above, which would go a long way to reducing confusion and promoting confidence in the market. I should note that this certification is not a forgone conclusion, and its fruition depends on support from a critical mass of industry participants. The RIA’s discovery process will continue well into 2022 and we will keep our members apprised of developments.

In the meantime, here are some useful tips for advisors who are navigating the ESG space. This is certainly not an exhaustive list, but it’s a good start.

  1. Development – The first and most important step is to acquire knowledge of ESG issues and the RI market. Advisors who are interested in taking a course can do so via the RIA Digital Academy, which has enrolled over 2,000 investment professionals to date.
  2. Strategy and process – Gain an understanding of a fund company’s strategy and process for incorporating ESG factors into investments. Determine how the fund manager performs ESG analysis and which of the RI approaches (listed above) they use.
  3. Voting – Check to see how a fund company votes at annual meetings. Do they vote in favour of leading ESG practices? Is their messaging consistent with their votes? Voting records are often published online.
  4. Engagement – Does the fund company engage directly with issuers to encourage leading ESG practices?
  5. CollaborationStudies have shown that investor collaboration can enhance engagement outcomes. Does the fund company collaborate with peers and industry bodies to amplify engagements and identify best practices?
  6. Advocacy – Not all institutions engage in policy advocacy or lobbying. But if they do, are they advocating for policies that are conducive to good governance and a sustainable and inclusive future?
  7. “Impact” should be measured – If a fund is marketed as an impact investment, the impacts should be measured. Look into how the impacts are measured and reported.
  8. Resources – All of this work requires resourcing. Check to see if the fund company has an ESG team to make it all happen.