Outsized ESG claims can challenge investors

Corporate sustainability reporting is often incomplete and self-reported, making it difficult to verify. However, regulators are beginning to scrutinize sustainability claims.

Earlier this year, the U.S. Securities and Exchange Commission sanctioned a firm for alleged mis-statements about funds’ ESG reviews, and last month the Competition Bureau began investigating RBC for alleged misleading marketing related to the bank’s action on climate change.

Conor Chell, head of the ESG practice group with MLT Aikins LLP in Calgary, said regulators are becoming increasingly sensitive to the threat of greenwashing as they anticipate the advent of mandatory, standardized climate disclosures.

But until such rules take effect, Chell said individual investors are forced to detect greenwashing themselves.

At the moment, Chell said a lot of sustainability reports are more qualitative than quantitative, so investors should be wary of superlatives such as “cleanest,” “greenest” or “industry-leading.”

“Those words really trigger me to say, ‘Well, what are you basing that assessment on?’” he said.

Although investors are looking for improvement in sustainability scores year over year, it is currently difficult for investors to effectively measure performance over time because of the wide variety of reporting practices.

In the future, Chell said sustainability reporting will become more data-driven. As mandatory reporting is phased in, he said there will be a shift toward quantitative reporting based on data.

“I expect that qualitative reporting will persist, but instead of being geared towards pure storytelling, it will be more focused on providing context and explanation to the underlying quantitative data,” he said.

That said, once mandatory reporting comes into effect, it will still take time before investors are able to assess year-over-year performance given the lack of standardization in reporting requirements and approaches to date.

Tim Nash, founder of Good Investing, said that in the meantime investors need to examine a fund’s methodology. “Don’t go by the name or the ticker symbol,” he said.

One way to avoid greenwashed funds is to look at their top holdings, Nash said. For example, he said if RBC is in the top 10 holdings of a fund that is marketed as “sustainable,” that might cause an emotional reaction for some Canadians given the recent allegations, and they shouldn’t be afraid to ask why.

This provides an opportunity for advisors to show their value. “Navigating these complex issues is where an advisor can earn their keep,” Nash said. When a client red-flags a company, he said it actually gives an advisor insight into where the “line in the sand” is.

The ultimate goal for advisors is to build trust, Nash said, so first and foremost, he said to acknowledge the client’s concern. Next, ask questions about why it is a red flag. This helps an advisor understand where a client’s ethical concerns lie, which in turn can be used to ensure they are in the correct funds.

“It’s very valuable information,” he said. “Often times, it’s hard for clients to speak up about these issues. So creating a safe space for clients to have these reactions to certain companies inside their portfolio is a really healthy thing.”

Last month, the U.K.’s Financial Conduct Authority proposed anti-greenwashing rules that are currently out for comment, and the European Securities and Markets Authority announced it was stepping up its scrutiny of ESG disclosure.