Do the funds that you manage from your investment firm carry the acronym “ESG” in their name and do they promise to select stocks or bonds of companies that are supposedly sustainable, but actually have in their portfolio companies whose medium and long-term business models are based on the extraction of fossil fuels or that have opaque value chains involved in human rights abuses?
These are some of the cases where organizations are promising something that they are not really in a position to deliver.
As capital flows to ESG funds have increased exponentially in recent months accelerated by the pandemic, many organizations see an opportunity to attract large amounts of money quickly by proclaiming themselves “sustainable” overnight and adhering to various initiatives or principles in the field that allow them to publicly display their so-called “green”, “social”, or “ESG” credentials.
The greater the gap between what they say and do, the greater the risk to which they are exposed: we are in the presence of the increasingly widespread phenomenon of greenwashing, or from ESG-washing in general if we take into account that these exaggerated or directly false “narratives” are not limited only to environmental issues, but also include social and corporate governance factors.
The ESG-washing then represents an ethical risk for all these organizations: at any time, some external or internal interest group (regulators, shareholders, employees, consumers, etc.) will take note of these inconsistencies and expose them publicly, with tangible consequences in terms fines and penalties, reputational damage, investor activism in pursuit of changes in the boards of directors and management of companies in which they invest, loss of clients, etc.
The integrity of these organizations is at stake here and, therefore, also their credibility, affecting the organization as a whole, not only in relation to these specific problematic issues that may come to light, but also to other issues on which your stakeholders will want to inquire as well, producing a potential “snowball” effect.
If, for example, a company regularly reports on its commitments and actions for gender equality and diversity but in its boards or in Senior Management there are no or few women or minorities represented, then one can assume that in the same way as the Organizations are “narrating” something that has no basis in reality, perhaps also in other aspects of their sustainability performance as well as the financial one, there may be inconsistencies that also deserve to be examined.
After some delay and largely pressured by a global citizenry increasingly committed to these issues – especially the younger generations and for issues that cannot wait such as climate change – governments are catching up and launching a battery of regulatory provisions that seek precisely to identify and, above all, prevent instances of ESG-washing.
A recent example has been the SFDR regulation of the European Union introduced in March 2021 and which applies to financial and investment entities on the continent. The objective of the regulation is for said entities to systematically disclose information regarding how they integrate sustainability criteria at the level of their entities and in their products and services, with particular emphasis on the risks and negative impacts of sustainability.
Investment firms and other players in the financial sector must then accurately disclose through consistent data and metrics how they are integrating ESG factors. This puts pressure on companies to consequently report robustly and transparently their ESG performance to attract capital from these actors in the financial system. Regulators of the financial system and asset owners (central banks, pension funds) from various countries are also implementing or considering implementing similar measures; Latin America is no exception in this regard.