Asset managers are treading the world of ESG carefully, focusing on a prudent approach towards greenwashing as regulators clamp down on non-compliant firms, increasing the risk of litigation.
DWS was fined $19m this week by the US Securities and Exchange Commission (SEC) for marketing itself as a leader in ESG while making misleading statements about controls for incorporating research and investment recommendations for ESG-integrated products, according to the SEC. A further $6m was levied for anti-money laundering violations, taking the total penalty to $25m.
“Investment advisers must ensure that their actions conform to their words,” said Sanjay Wadhwa, deputy director of the SEC’s division of enforcement and head of its climate and ESG task force.
In Germany, DWS’s investigation by the Frankfurt public prosecutor’s office and the financial regulator BaFin is still ongoing, after the asset manager’s offices in Frankfurt were searched by authorities last year, and it is still unclear whether this will lead to a fine, according to news service tagesschau.de.
In a statement, DWS has said: “We are pleased to have resolved these matters that relate to certain historic processes, procedures and marketing practices the firm has since addressed. The SEC ESG Order, following an extensive two-year examination, finds no misstatements in relation to our financial disclosures or in the prospectuses of our funds. We have consistently stated that we stand by our financial disclosures and disclosures in our fund prospectuses.”
DWS added: “The Order also makes clear that there was no intent to defraud, and the weaknesses identified by the SEC are in relation to processes and procedures that the firm has already taken steps to address.”
“We are pleased that the SEC recognized our cooperation in the investigation and our remediation efforts,” the firm added.
Last year the SEC also fined BNY Mellon and Goldman Sachs over ESG misstatements.
Letter and sprit of the law
According to Nordea Asset Management’s head of responsible investments, Eric Pedersen, asset managers have to be “very careful” when marketing funds and avoid the risks of greenwashing, not only because ESG is now regulated, in Europe and elsewhere, but also prevent another loss of confidence in the industry.
“It’s not enough to just follow the letter of the law – you should think about what is the spirit of it, and perhaps most importantly: what would the end investor, the retail client, the member of a pension fund expect from you, when you make certain claims and use certain words?” he said.
The asset management industry needs to be clear on the features and impact – or lack of – in an ESG product.
“You can still find examples of corners being cut and holdings in ’sustainable’ funds that would raise eyebrows with a lot of the investors who are in the market for that type of investment,” he said.
Another asset manager, which did not want to be named, said it tried to be as transparent as possible by not overpromising or being overambitious with regard to ESG, for example classifying certain products under article 6 instead of article 8 of the Sustainable Finance Disclosure Regulation (SFDR), and rebranding a few products from article 9 to 8, to avoid greenwashing risks.
Serious reputatational risk
The manager also tries to gauge the intentions of regulators, using a sensible approach on ESG investing. Asset managers are now likely to be very careful after the fine incurred by DWS, the asset manager said.
Nordea’s Pedersen said: “Reputations can suffer serious damage if one does not have solid arguments when confronted on ESG. One thing that is often not clear enough is whether a strategy is built to address only the financially material ESG factors, or also the environmental and socially material ones – the negative externalities of the economic activity of companies.”
There are ESG ratings focusing almost exclusively on financially material ESG risks and how that is managed by companies.
“Now, basing a strategy on scoring high on ratings like that can be great from a pure portfolio risk point of view – but if a values-based, sustainability-focused investor buys into it, thinking it will address her or his deeply held concerns about environmental or social issues, you could have a case of involuntary greenwashing on your hands,” Pedersen said.
Mirova’s head of sustainability research, Mathilde Dufour, said investors have a certain degree of freedom to allocate assets sustainably, meaning ESG is not restricted to a niche but that the obvious disparity in article 8 funds poses the question of greenwashing.
“Right now, we believe the most important is to be as transparent as we can with our clients, by explaining clearly our ESG approach and our definition of what we consider to be sustainable,” she said.
It is key for investors to take greenwashing seriously, according to Dufour, to source the best information they can, and for asset managers to protect their credibility, as with the proliferation of regulations the risk for litigation rises.
Heavy regulation can bring litigation risk
Law firm Linklaters has observed an increasing volume of ESG legislation globally, and particularly in Europe, becoming extremely complex and changing fast.
Regulation intends to fight greenwashing through different means including accountability through disclosure, for example with the SFDR, the UK’s Sustainability Disclosure Requirements (SDR), the Task Force on Climate-related Financial Disclosures (TCFD), and the Taxonomy Regulation.
“We’re seeing regulators exploring the ways to fight greenwashing through specific guidelines, for example the planned UK greenwashing rule and the ESMA consultation on greenwashing. What we’re also seeing is that the concept of greenwashing is changing – regulators seem to see unintentional acts or omissions as a case for greenwashing,” said Julia Vergauwen, investment funds counsel at Linklaters.
The risk of greenwashing increases, considering the fast changing ESG regulatory landscape and the fact that in Europe particularly, with the SFDR, the regulation places the responsibility on the industry’s shoulders to interpret the law correctly.
“Moreover, certain national legislators have created their own labelling regimes which are not aligned. This means at the moment the industry is allocating a lot of resources to get it right and not to be blamed for greenwashing,” Vergauwen said.
Although regional regulatory requirements may differ, the SEC in the US, with amendments to improve disclosure requirements for terminology in prospectuses, and ESMA in the EU with a consultation, are tackling the issue of fund naming rules.
“We believe this trend is very encouraging as it aims to provide transparency to both professional investors and savers, and thus reinforce the credibility of committed asset managers,“ said Dufour.
Navigating divergent regulations
Implementing different regional regulations that are not harmonised is one of the main challenges for asset managers.
“The same goes for the numerous existing labels, which do not necessarily share the same criteria. This poses a very concrete difficulty for asset managers to find a common thread that allows for transparency and regulatory compliance across all portfolios,” Mirova’s Dufour added.
In Europe, a gap has emerged between the initial intent behind the SFDR, considered originally as a purely transparency exercise, and its use.
“It has been used as a label by asset managers, while no specific criteria has been set like it is usually the case for labels. As it is, article 8 funds encompass most of the funds, with various nuances, while article 9 funds seem so restrictive that only a few players dare to [classify] their funds [as such],” she added.
Mirova believes that indications on the level of exclusion for each category might help clarify the goals for each category, and ultimately for investors. “We hope the recent consultation launched by the European Commission will help address this crucial issue,” Dufour noted.
The Taxonomy and the SFDR have introduced new terms and definitions, splitting asset managers and asset owners into two groups.
Pedersen said: “Those who already had an ESG and responsible investment framework in place, which then needed to be adapted to encompass the new terms introduced, and those who had none and had to rush to build something.”
But both groups need data sources to cover the definitions introduced, and pick the right investment strategies. With an increasing volume of regulations, and especially looking at SFDR, investors need to introduce a robust governance around ESG, he said.