Greenwashing at a tipping point: Marketing jargon poses regulatory risks

The environmental, social and governance (ESG) fund industry was at a crossroads on August 26, 2021.

That day, investigations by the SEC and German regulator BaFin were launched into allegations that Deutsche Bank’s DWS had exaggerated the claimed ESG integration of a few of its funds. reported within the press.

With the top of this age of innocence, ESG marketing jargon become an actual regulatory risk with real consequences: DWS shares fell by about 15%, representing a lack of €1.2 billion in market capitalization, and have yet to actually recuperate.

Possible mis-selling by DWSa serious allegation within the UK, was made by the federal government and caused fear throughout the industry.

Another fundamental change was the transnational nature of the increased regulatory control of the ESG fund complex.

The US investigation found that the brand new Task Force for Climate and ESG was greater than just regulatory greenwashing. In fact, BaFin only began its investigation of Germany-based DWS after the SEC had launched its probe. The German regulator would have had a tough time explaining why it didn’t investigate allegations against an organization under its direct supervision while it did so against a foreign company.

Shortly before the DWS news became known, The Financial Conduct Authority (FCA) has asked all UK asset managers to make sure that ESG fund products have sufficient resources amid the avalanche of latest ESG fund launches.

Managers must balance the parabolic growth of the ESG fund sector with the upper costs of managing these products and potentially significant regulatory risks. The winners of this lucrative race will likely be those that can concretely show that various ESG inputs are literally integrated into the products on the fund level.

This is a natural a part of the sector’s maturation process. Asset owners’ priorities when allocating to ESG funds are continuously evolving. The following graph, based on data from BNP Paribas, shows the speed and direction of this evolution:

The most significant aspects when choosing an ESG manager

Source: BNP Paribas

In 2017, a compelling ESG mission statement was crucial data point in choosing the ESG manager.

Subsequently, fund performance and reporting became more necessary.

The next key selection criteria will likely be the manager’s ability to show how ESG considerations are incorporated right into a fund’s investment and research process.

As recent events show, the pressure will come not only from asset owners but additionally, increasingly, from regulators and non-governmental organizations (NGOs).

Of course, all fund products should deliver on their guarantees. But given the societal importance of ESG goals and the priority given to them by most G7 governments, regulatory scrutiny of ESG funds will only increase.

There are three predominant priorities for asset managers managing ESG funds:

1. Control rising ESG costs, including those around data and administration.
2. Demonstrate that fundamental and ESG considerations are taken into consideration at fund level. ESG criteria alone usually are not enough. A portfolio can’t be run on the premise of CO2 data alone. Additional fundamental data is required.
3. Make sure that the Crowd of ESG inputs and their integration is acceptable for the fund product. This can vary considerably from fund to fund.

The broad range of fund objectives and the variability of ESG aspects applied to the funds are shown in the next graphic:

Few managers, even those with long-standing and mature ESG processes, have overcome the challenges related to this area. Managers must evaluate and attribute inputs, including ESG databases and proxy advisors, which don’t lend themselves to the document/interaction counting that usually drives fundamental research evaluation. And several types of funds – Articles 6, 8 and 9 – require different considerations to various degrees.

This can provide conclusive evidence to asset owners and regulators that a manager’s ESG products have sufficient and appropriate inputs while also addressing the difficulty of cross-subsidisation.

This process will enable managers to shut the loop in an effort to systematically speed up the launch and development of their ESG products across all asset classes.

Managers who rise to this challenge and may show true ESG integration to asset owners and advisors will likely be well positioned to capitalize on the expansion potential of the ESG category.

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Photo credit: ©Getty Images / Greg Pease