Greenwashing must be tackled at ‘critical moment’ in ESG investment sector’s maturity, experts warn
EY has published a major new report defending the ESG investing and disclosure movement, outlining how snowballing concerns around greenwashing present an opportunity to intervene and create a thriving sector, not a reason to scale it back.
The professional services giant’s new report on ‘the emerging sustainability information ecosystem’ provides an overview of the massive growth in ESG-related disclosures and investing in recent years – and how, without standardisation and regulation, the sector is facing mounting accusations of failing to deliver the positive environmental or social impacts it claims to.
On the growth piece, the report states that the total amount of assets under management covered by specific ESG funds reached $2.7trn in 2021, marking a 53% year-on-year increase. But as the movement’s support grows, the report notes, the perception that ESG is ineffective is also becoming more widespread.
EY acknowledges that many companies, ratings agencies and investors are using different definitions of ESG and different methodologies to assess performance across each of the three pillars. Some of these methodologies are based on historic data, some on future predictions. Some assign more importance to issues which are less material to a particular sector or project than those which materiality assessments have proven to be key. Some assign more weight to the ‘E’ and/or the ‘S’ than the ‘G’.
These discrepancies have led to rating agencies assigning scores which have caused controversy. Many of these controversies are now making mainstream news. For example, MSCI and Sustainalytics both provided high ratings to care home operator Opera Group, which this year was accused of mistreating residents and faced insider trading allegations. To give another example, in 2020, fast fashion retailer Boohoo was revealed to have the backing of 20 ESG-focused funds, despite persistent and credible allegations of supply chain workers being paid illegally low wages.
In many geographies, EY notes, there has been only light regulatory and legislative intervention in the ESG investing space. This could well be set to change as the effectiveness of ESG rating systems is continually called into question in visible spaces. In the UK, for example, the Financial Conduct Authority (FCA) recently stated that it is willing to enforce stricter regulations for ESG data and rating providers.
“In this critical moment, we examine some of the key dynamics shaping the emerging sustainability information ecosystem and provide our views on how both decision-usefulness and trust in sustainability information can be strengthened,” the foreword to EY’s report reads. It is co-authored by the firm’s global vice-chair for sustainability, Steve Varley, and global deputy vice-chair for public policy, Katie Kummer.
Kummer added: “Many of the current challenges facing ESG are a product of its infancy. The sustainability ecosystem is just more than 20 years old, and so still in its maturing stage compared to the financial reporting ecosystem. It is essential that we work together to build a system that is globally consistent, trusted, responsive and where everyone has a voice.”
Five calls to action
Instead of simply doing away with ESG as a term and framework, EY argues in favour of a “whole-system approach” to stamping out impact-washing, improving the quality of data and the ways in which it is interpreted and reported.
The report calls for ESG data and ratings agencies to be more transparent about how they source their data and calculate their scores. These firms could be assisted in this activity by having a shared, legal definition of key ESG-related terms and how to measure progress against them. For example, the report highlights that there are often differences in how companies calculate and report indirect (Scope 3) emissions, in terms of where they set their boundaries and whether they use direct or proxy data. It also acknowledged that performance against some social and governance topics is even harder to quantify than environmental performance. However, the report stops short of explicitly recommending a legal mandate for ESG data and rating firms to increase transparency in a certain way.
Increased transparency – whether voluntary or mandated – will help increase investors’ understanding of sustainability information, the report argues. It also argues that this could pave the way for more understanding of different ways in which to use this information as an investor, looking not only at managing financial risk but assessing, for example, opportunities for innovation and social change.
All ESG data and rating agencies, as well as corporates publishing ESG data, should be supported to use third-party, independent assurance for their claims, EY argues. The report notes that this could soon become mandatory in places like the EU and US and that, without this, “it will be difficult to both build trust and avoid the pitfalls that come from lacklustre information management and controls”. Yet just half of the world’s largest businesses have already achieved assurance over their sustainability disclosures, the report reveals, with most having their disclosures deemed as “limited”. EY sees this picture changing rapidly, with policy intervention as the main driver of change.
The report notably highlights that ESG-related data is, in general, more abundant and of better quality in nations than in the Global South. It argues the case for developed nations to share best-practice and for companies with multinational operations and value chains to undertake “more upskilling on technical assistance” to help close the data gap. Developing nations, meanwhile, are encouraged to incorporate the International Sustainability Standards Board’s (ISSB) emerging standards into their legal frameworks. The report does not advocate different, lower standards for wealthy and developing nations, stating that this would be “counterproductive” and not encourage a race to the top on environmental or social topics.
The final topic covered with recommendations from EY is sustainable finance taxonomies, with a focus on implementation in developed markets. Implemented by governments, these taxonomies define which activities can credibly be classified as “green” or as “transition” activities. The EU is set to be the first place to implement a dedicated green taxonomy, but its inclusion of some gas and nuclear activities has prompted fierce debate. The UK is developing its own taxonomy and, while differences are likely in this post-Brexit world, it is likely to follow the EU’s approach in the main – which has fostered climate concerns, especially given the Conservative Party’s recent renewed support for expanding fossil fuel extraction.
EY’s report emphasises the importance of having “interoperable and comparable” taxonomies globally. Differences, it recommends, should be accounted for by “clear, data-driven” explanations; for example, a nation deeming gas “green” would need to explain why to another nation excluding fossil fuels completely. The report points to the World Bank’s guidelines to developing national green taxonomies and forecasts that emerging economies are likely to soon follow the EU’s lead. Indeed, the bloc is already working with China on this topic.
Join the conversation during edie’s Green Finance Focus Week
Readers interested in the ESG investment debate are encouraged to take part in edie’s ongoing Green Finance Focus Week (18-22 July).
Throughout the week, the edie editorial team will be publishing a range of features, interviews, reports and more to inform and inspire readers around making sense of the ESG landscape and scaling up finance to accelerate the transition to a sustainable future. We will also be hosting a series of online Inspiration Sessions on the afternoon of Thursday 21 July, sponsored by Inspired Energy and featuring expert speakers from organisations including Natwest, Standard Chartered and the We Mean Business Coalition. Click here for details and to register.
© Faversham House Ltd 2023 edie news articles may be copied or forwarded for individual use only. No other reproduction or distribution is permitted without prior written consent.