ESG's Alphabet Soup Needs Fixing To Avoid Greenwashing, Misselling
One of U.K.'s ESG pioneers talks on the need to simplify language around ESG products and funds.
One of the pioneers of U.K.'s ESG industry has a simple activity to highlight why the sector is under increased scrutiny for greenwashing and misselling: host a dinner for a group of people.
"If you host a dinner and ask everyone what ESG is, you'd get as many answers as the number of people you invited," Paul Moody, managing director of global partnerships and client solutions at the CFA Institute, told BQ Prime. "There are too many definitions and types of categories of ESG right now. Leaving it up to the investor to work out what that is, is not going to be consistent."
Therein lies one of the biggest challenges plaguing the environment, social and governance based investing, Moody, who helped build U.K.'s first ESG products at Aviva Investors, said. "We need to simplify the language around it. We need a common definition, shared best practices, and a set of codes and standards. When people apply those, they will know exactly what they're buying into."
There are no common standards. It is an 'Alphabetti Spaghetti' in terms of jargon out there.Paul Moody, Managing Director (Global Partnerships and Client Solutions), CFA Institute
The lack of common standards and definitions, as reported by BQ Prime earlier, is what paves the way for greenwashing and potential misselling of ESG products.
That's exactly what has drawn the ire of the U.S. Securities and Exchange Commission and other regulators. The SEC is investigating Goldman Sachs's mutual funds for misleading investors about their ESG criteria. Deutsche Bank is facing similar probe in Germany, while ESG funds in other countries are being viewed with some skepticism.
Moody said that much of the misselling in the industry is "unintentional" mainly because the people selling ESG products are not aware of it. There is a disconnect between what the financial advisers or fund managers tell their clients about ESG, and how investors perceive it.
"Certainly in London, where the market exploded in the last two years, there's no talent available of people who actually know what they are doing," he said.
Besides, the lack of a common approach also sends mixed signals to companies on what qualifies them to feature in an ESG category. "They all have different approaches and they're trying to just look better than each other. And they don't really know how to get there."
There's definitely a gap between knowledge to execute and the grand gestures that are made. I don't think any of this is intentional. Is it a worry? Yes. Is it intentional? No. But is it excusable? No.Paul Moody, Managing Director (Global Partnerships and Client Solutions), CFA Institute
"Because if I put my money in something which is billed as an ESG fund, without a clear definition, I'll probably make my own definition of what it is. And that's the first opportunity for potential misselling," he said.
Moody said the ESG industry would be a lot more protected though having clear standard definitions. That would make it possible for audits to be done on whether a company is fulfilling its ESG commitments. It will also make the lives of financial advisers easier as they will be able to sell to their clients exactly what they require.
"If I say ESG, you might assume 'Oh we're investing in all the good things'. So you would think I will not invest in high-polluting industries and in companies that look after their employees, have high diversity etc. But it is not as simple as that and that is the problem," he said.
"That is why having clear definitions is key to knowing what you're buying. And that doesn't mean coming up with new words and new taxonomy. Just things that normal people can understand."
Here are edited excerpts from the interaction:
What do you make of the increased scrutiny that ESG industry is facing from regulators and investors?
I spoke at a conference in Switzerland and there were regulators, academics, and asset managers there. Every single person who spoke has talked about greenwashing. This is probably before any of the current cases had come out at the time.
It is clearly obvious that the media has now picked up on this. The regulators have picked up on this. My evidence is that none of this is intentional. I've worked in asset management for 20 years. And nothing anybody did was intentional.
Having said that, there is a lot of potential misselling unintentionally. One reason is the lack of knowledge, understanding and a lack of education. Certainly in London, where the market exploded in the last 2 years, there's no talent available of people who actually know what they are doing. Anyone who did know what they were doing got hired to different firms. So you've got this huge gap in talent. People are hiring people who don't know what they are doing. That's the first opportunity to make mistakes.
The other thing is there's no common standards or approach. It is the same as I was with my asset manager. You try to keep your information proprietary. And that means you'll get different answers from each one to the same question.
It's an alphabetti spaghetti in terms of jargon out there. And each regulator is trying to out-regulate the other. So you keep getting more and more regulation.
Has ESG turning into a buzzword been to the detriment of the industry?
At a roundtable in India on ESG some time back, I used this quote from Arthur Schopenhauer that the revelation of any truth goes through three stages. First it is ridiculed. When I said ESG, people said this is just for hippies, there's no place for this in proper investing.
The second stage is resisting and I thought that will never end. People were saying fiduciary duties about making money. They couldn't see profits and sustainable investing as being symbiotic.
And the third stage is that it becomes self evident and now every CEO of every asset manager is saying I've always believed in it.
So you can see here why we've got an opportunity for greenwashing. Because they are all of a sudden positioning themselves as leaders, they don't know what they are doing, they don't understand the data and they don't have any common standards to define any of it.
Do you see a disconnect between what fund managers see ESG as, and what the investors' expectation are?
Investors perceptions of ESG are wildly different.
If I say ESG, you might assume 'Oh we're investing in all the good things'. So they would think I will not invest in high-polluting industries and in companies that look after their employees, have high diversity etc. But it is not as simple as that and that is the problem. That is why having clear definitions is key to knowing what you're buying.
Part of it will be informed by different ways from what your perceive. None of them are right or wrong.
They key to answer is that if one is investing in positive impact—what does that mean? If you're investing in transition—what does that mean?
We need a common language so the investor knows very clearly what that stands for. And that doesn't mean coming up with new words and new taxonomy. Just things normal people can understand.
For companies making ESG commitments at the board level, is the lack of capacity at the managerial level a reason why we don't see those pledges turn to action?
When we started out and I was at an insurer, they had a big team of scientists looking at climate change. It is because we were looking at increased claims from flooding and physical disasters. They wanted to understand the long-term impact of that. So there was expertise but it wasn't classed as ESG.
At the end of my time there, they said okay Allianz and AXA have come out with really ambitious statements around their pathways to net zero. We need to do something better. On one hand, that is quite good. But did they actually understand what they were committing to? We signed up to that. But how to implement it, is a different matter. It is an ambition statement.
That's one of the problems with the commitments made. They are long-term commitments and CEO tenures are shorter. Same as politicians. It is an easy stand to take with long-term commitments. I'd rather have them make the commitment, than not. But it is a big gap from commitment to execution at the moment. And for that you need people to know what they are doing. And you need to democratise the information and knowledge better.
All the asset managers signing up to net zero commitments, and people talking about trillions of money directed to that way. There is that, but it is actually sending mixed signals to companies. They all have different approaches and they're trying to just look better than each other. And they don't really know how to get there. You're not going to make capital cheaper and give oxygen to the better companies, that way.
There's definitely a gap between knowledge to execute and the grand gestures that are made. I don't think any of this is intentional. Is it a worry? Yes. Is it intentional? No. But is it excusable? No.
Because if I put my money in something which is billed as an ESG fund, without a clear definition, I'll probably make my own definition of what it is. And that's the first opportunity for potential misselling.
Then there are people who don't know actually how to do it and that's the second unintentional misselling.
Is there a case to be made to look at E, S and G separately and not club them in one singular bouquet?
You could do. But they often are overlapping. I'll say yes and no.
If you're looking at climate, it will have huge impact on social aspects like inequality going forward. Probably create conflicts over things like water resources. So it will exaggerate social problems.
A company which doesn't have good governance in place, will be susceptible on environmental and social performance.
But in some ways, it is also cleaner to look at them in isolated ways. It is neater.
The data for environment is incredibly hard. You got some things you can rely on like the Science Based Targets because it provides you with clear auditable processes to look at the environment aspect. I'd suppose that takes away the governance bit for it because then a company can be held to account through that.
When you get to social, what's your definition of social compared to mine? And the data is even more imperfect. Despite all the progress made, it is still ambiguous. And it is difficult to pick apart, as you get different answers from different people.
It makes it cleaner. But it is a very difficult answer to give.
They're all linked.
Can the regulatory probes and increased scrutiny lead to a better ESG investment environment?
There is a need for much clear definitions of when you're buying a fund, what that fund is actually doing. Because there are too many definitions and types of categories of ESG right now. Leaving it up to the investor to work out what that is, is not going to be consistent.
If you had common definitions, and then it is broken down to be consistent across asset classes, consistent across geographies, then you as an adviser you know if you're promoting that to a client. And you can take that information and you'd be protected when you give it to your client. Then you could have that process audited to make sure the fund manager is doing what they said on the tin.
If you had common standards, shared best practices, set of codes and definitions. When people apply those, they will know exactly what they're getting. Then if you did have any greenwashing, it'd be malicious and intentionally so.
We just need to simplify to language around it. How many people in a restaurant would understand if I tell them about say Scope 3 emissions? What would that mean to them?
If you host a dinner and ask them what ESG is, you'd get as many answers as the number of people you'd invited. There needs to be clear explanations for people to know what they're investing into.