As the move towards ESG gains momentum, so does the risk of ‘greenwashing’. In Europe, investment managers that have merely paid lip-service to ESG commitments are incurring hefty fines under the European Union’s Regulation on sustainability-related disclosures in the financial services sector (SFDR). However, even without stringent regulations, investors are becoming a lot more savvy.

At the 8th Fund Summit, a panel of industry experts debated the risk of greenwashing in Australia and how to mitigate against it.

Konstantina Founta, Head of Risk Analytics APAC at State Street, said that while Europe is leading the way on regulation and compliance, the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority are also increasingly focusing on ESG.

“In Australia, we have clear directions from APRA and ASIC on how both asset owners and asset managers should go about [managing for ESG] and there have been interventions about greenwashing. ASIC is actively engaging and asking firms to remove statements from sustainability disclosures when these are not supported by evidence. This is the way forward, as we also see this happening in the US. It is not about what you say, it is about what you do at the end of the day and that is what the regulators will want to see from now on,” Founta said.

However, even without the added pressure of regulation, institutional investors are demanding action.

Joel Posters, Head of Investment Stewardship and ESG at the Future Fund, said that the Future Fund takes a proactive approach to ensuring its investment managers are aligned and are truly embedding their principles into the investment process over the course of the investment period.

“We assess our managers both at the point of onboarding as well as periodically throughout the investment process,” Posters said, adding that Australia’s sovereign wealth manager will only agree to a meeting on ESG topics if senior investment members are present and active in the dialogue.

“Otherwise, that dialogue tends to be suboptimal,” Posters said. “Managers are getting a lot better at telling the ESG story and that is good for the most part, but […] the task of asset owners like us is to go deeper into the nature of the portfolio, the risks, the opportunities, [to ask for] concrete examples, test out those business cases and really try to identify risks and opportunities associated with their portfolio. That is often still a very difficult question for some of the portfolio managers to answer,” he said.

Posters said there were a number of common warning signs that can indicate a manager is ‘talking the talk’, but not necessarily ‘walking the walk’ in practice.

“One of the biggest red flags to me is when we enter into discussions with senior members of the fund talking about investment performance, investment rationales and so forth, but when it comes to ESG they hand over to the legal team, the investor relations (IR) team, or to a designated ESG person. To me, that can imply that it is not front of mind with the key decision makers of that particular strategy,” Posters said, who said a similar disconnect can arise when portfolio managers are able to vote differently to the group voting intention that is disclosed publicly. “Sometimes that’s ok, but there has to be a level of transparency around it,” he said.

Similarly, portfolio reporting can show meaningful insights. “What I sometimes see is that quarterly portfolio reports that are sent to our sector teams don’t contain any mention of ESG, despite the fact that ESG is often a major talking point in our discussions with these fund managers. That can also signal a disconnect between what they say is important and what they really believe is important. By and large however, our fund managers have gotten more sophisticated at integrating these issues in their business,” Posters said.

The growing focus on ESG and the extent to which investments are ‘accurately’ labeled can be quite challenging to meet, however.

Richard Morris, Head of Responsible Investments at Perpetual, said that ensuring that products are true to label is a key requirement, but added that there are considerable grey areas that can complicate those assessments.

“You have to be really careful that you are not creating that impression that you are doing more or that you are greener than what you are. For us, it is really about doing what makes sense to our business on ESG and then explaining that within the context of risk and return, rather than the other way around, which in some instances, involves investors signing up to an objective or an initiative and find they can’t actually deliver, but it is a real grey area. Greenwashing is subjective,” Morris said.

While data plays a critical role when measuring, reporting and monitoring progress towards ESG targets, the absence of a common set of standards, coupled with limited coverage across both asset classes and geographies in the APAC region in particular, means that investment professionals have their work cut out for them.

“Different vendors typically have a different focus and market participants need to dig in and understand what the fundamental approaches of that data vendor are and align those with their investment philosophy and ESG targets,” Founta said.

“Finding the right vendor for your asset class, understanding the data and presenting the data is a big challenge and – in relation to greenwashing – how you use that data to actually communicate your targets to your investors is another challenge,” Founta said.

Walking the walk to net zero

The panel agreed that the recent move towards net zero, positive though it is in terms of impact, is creating additional challenges. That’s partly due to the sheer numbers of fund managers that are publishing commitments and working out how to meet those later, a potential textbook case of ‘greenwashing’ in action. However, it’s also introducing an entirely new way of measuring performance, as well as creating potential conflicts between short-, mid- and long-term objectives.

Perpetual’s Morris said the net zero focus has changed the goalposts from essentially looking at integrating ESG in the context of risk and return frameworks, to focusing squarely on real world returns.

“This is a massive challenge that many fund managers are working their way through at the moment. The ESG conversation used to be about fully integrating ESG concepts into your analysis of risk and return, whereas now there is this tremendous push to go beyond risk and return to pursue real world impact,” Morris said.

Further complicating matters is that there are times when the impact objective may not align with the performance objective, at least not in the short run.

“Sometimes, the real-world impact decision will be aligned with the performance objective, but sometimes it won’t, particularly over short and medium term timeframes, so how does the portfolio manager manage that potential conflict on a day to day basis? That is where you really get the challenge,” Morris said.

“Even on asset owners there is still a lot of pressure on medium- and shorter-term performance. If you look at how strongly the energy stocks have performed over the last 12 to 18 months, that is one example of where you have a short to medium term conflict,” Morris said.

At the Future Fund, Posters looks for assets that can meet both requirements. “One of the things that we have done a lot of lately is investment in renewables. [..] We made those investments, because we think those assets will provide an excellent risk-adjusted return as we transition to a lower carbon economy. We don’t do it solely because it creates impact, but we recognise that these drivers are starting to converge, which means that what generates impact may also generate investment returns, especially over time,” he said.

Again, the analytics aren’t there yet to reliably identify whether organisations have a real roadmap to transition towards a more carbon friendly environment, but there are certainly indicators that can help.

“We tested a number of [transition data points] earlier in the year and to, frankly, we found all of them lacking in some way, shape or form and that is not surprising. This is an ongoing field of expertise that a lot of these companies are trying to get their heads around,” Posters said.

Instead, Posters said the Future Fund looks to information on roadmap quality, depth of scenario analysis, quality of the management team and board and track record of capital allocation and sound decision making. “Managing carbon transitions is not exactly an established skillset at the end of the day. This is something that investors really need to have an understanding of, to what extent they can have conviction in these companies being able to [achieve those goals]. Asset owners also play an important role in conveying expectations and driving enhanced performance in this area,” Posters said.