On June 1st 2022, Asoka Wöhrmann stepped down as the CEO of DWS, the asset management subsidiary of Deutsche Bank. He announced his resignation hours after the German police and BaFin authorities raided the offices of DWS and the headquarters of its majority owner Deutsche Bank. The company, which has €902bn worth of assets under management, is being investigated for greenwashing. The authorities were following up on news reports and a whistleblower's allegations that DWS marketed and sold their investments as "greener" or "more sustainable" than they were. Additionally, according to the allegations DWS accounted for environmental, social and governance (ESG) factors in only a minority of investments "but were not taken into account at all in a large number of investments".
Last year, the U.S. Securities and Exchange Commission (SEC) and German financial watchdog BaFin launched separate investigations into allegations made by DWS' former head of sustainability that the company was overstating how it used sustainable investing criteria to manage investments. Regulators and policymakers have pledged to clamp down on companies that make exaggerated claims about the sustainability credentials of their products as they try to cash in on booming demand for ESG investing.
A recent study in this regard revealed that 20 of the world's largest ESG funds had, on average, 17 fossil fuels companies in their portfolios.
According to a recent report, issues with data were at the heart of sustainable - investing problems. Many observers see the raid at DWS in this regard as a critical moment in recognizing greenwashing as prospective fraud. In light of these recent developments, it has become crucial for companies to understand greenwashing as well as its relationship with data to prepare for the future.
Greenwashing or 'green sheen' refers to the practice where an entity exaggerates or misrepresents its sustainability credentials. The term "Greenwashing" was coined by American environmentalist Jay Westerveld in 1986 while pointing out the irony of hotels that placed notes to re-use towels to save the environment while doing nothing or little for the cause. This was understood to be a strategy to reduce costs rather than protect the environment.
Greenwashing strategies thus primarily employ manipulation tactics. For example, by designing subtle, misleading packaging, a brand may suggest that a product is eco-friendly even when it’s not. Greenwashing tactics also include making assertions with ambiguous or insufficient proof to back them. A common element here is using environment-conscious verbiage without revealing any specifics.
As investor and stakeholder priorities move toward sustainability, it has created the need for companies to be more accountable in managing their ESG disclosures. This movement has also led to a sharp rise in the number of companies that have been accused of making misleading claims about their eco-credentials.
Some instances of greenwashing in the recent times are:
In May 2022, the SEC fined BNY Mellon $1.5 million over their ESG claims. Regulators found that BNY Mellon was guilty of making “…misstatements and omissions concerning ESG considerations.”
Automobile companies Volkswagen and BMW were found guilty of using emission cheating software to present their vehicles as environmentally conscious. In 2021, Volkswagen was fined 502 million euros and BMW 373 million euros by the European Commission.
In 2020, Italian-state-backed energy company Eni was fined €5 million for stating that its fuel had 40% lower GHG emissions than its competitors, without having sufficient proof to buttress this claim.
The United States Federal Trade Commission (FTC) penalised popular retailers Kohl's and Walmart for making false environmental claims. Having been found guilty of greenwashing, Kohl's and Walmart were fined US$2.5 million and $3 million, respectively.
A campaign by oil and gas company Royal Dutch Shell (now Shell plc) promoting "carbon-neutral" fuel purchase was considered greenwashing by the Dutch advertising watchdog. The ad campaign known as ‘‘Drive CO2 Neutral" promoted an offer where customers could choose to pay an extra amount that would finance carbon offsetting projects. The ad was misleading as it suggested that the offsetting undertaken would match the emissions generated by using the fuel.
As many oil companies have been making claims about transitioning to clean energy, a recent study has found that accusations of greenwashing made against them are well-founded. A Carbon Market Watch investigation in this regard states, "Like dry water and hot snow, carbon-neutral fossil fuels are pipe dreams and marketing gimmicks that do nothing to protect the climate."
Impact of Greenwashing
These cases have raised questions about the credibility of the ESG disclosures made by companies today. Regardless of the scale of greenwashing a company undertakes, it not only slows the efforts made towards meeting net-zero targets but also considerably impacts businesses in the following manner:
The rampant greenwashing today has triggered a crisis of confidence in investors and consumers alike. This not only affects a company's reputation but also results in financial losses. For example, reports revealed that share prices of DWS fell by 1.8% and those of Deutsche fell by 1.9% after the raid.
It undermines brand image and consumer confidence which could translate into financial losses. The impact of greenwashing on consumer loyalty and satisfaction is evidenced in a study undertaken by Shift Insight which revealed that greenwashing could result in a loss of revenue as 48% of the respondents said that they would shop less from a company found guilty of greenwashing while another 14% said they never purchase from the company again.
If found guilty of greenwashing, the litigation costs and the potential penalties could take a considerable toll on time, money and other resources. For instance, the class action taken against ConAgra for falsely marketing Wesson cooking oil as 100% natural lasted for eight years. Apart from the legal fees they had to pay for those many years, they had to pay $27 million for damages and reliefs as well.
In addition, it threatens to discredit honest and sustainable practices carried out by responsible corporate actors. A study in this regard revealed that one of the main factors contributing to green scepticism is the increasing number of corporate misconducts.
Amidst the rapid proliferation of sustainability claims being made, governments and regulatory bodies have been taking steps to increase transparency and hold companies accountable. In addition, governments have also begun to take legal sanctions to prevent greenwashing. Some of the developments are as follows:
On May 25 2022, the SEC announced the ESG disclosures Proposal. If adopted, it would help in articulating disclosure requirements for funds that promote themselves as having subscribed to ESG principles. It would require ESG funds to divulge information about the ESG factors they consider, their climate goals, strategies they've adopted to meet these goals and the data to measure progress.
U.K.'s Sustainability Disclosure Requirements (SDRs) aim to set an integrated framework which will help in sustainability-related reporting. Likewise, Denmark has set up a unit specifically to monitor investors' sustainability disclosures. The EU, New Zealand, Hong Kong and Japan are also adopting similar measures to encourage sustainable business practices and standardise disclosures.
In France, if a company is proven guilty of greenwashing, it could be fined up to 80% of the cost of its false advertisement campaign, in addition to making corrections on advertising platforms and publishing a clarification on the company website. Greenwashing is a punishable offence in the Netherlands, and companies found guilty could be penalised for it.
The European Union, too, has made strides in devising strategies and implementing programs to combat climate change as it is committed to becoming a climate-neutral continent by 2050. One of the promising efforts made towards this end is their attempt to develop a legal definition of greenwashing. This would play an essential role in setting boundaries on what practices are acceptable and what are not. The European Securities and Markets Authority (ESMA) believes that effectively applying the E.U. sustainable finance rulebook will bring down greenwashing practices. In addition, a report published in March 2022 by the European Commission articulates what a company can or cannot say to its customers. It mandates that generic terms such as "carbon neutral" or "eco-friendly" in reports be substantiated with verifiable data.
Greenwashing and the data problem
While the regulatory developments are a welcome move, several challenges persist in formulating and verifying ESG disclosures. These problems are primarily data related. Even in the case of DWS, the main issues were data related. Specifically, (a) the fund managers at DWS ignored calls to use data to judge which investments to make; (b) used outdated data; (c) averaged other firms’ ESG ratings in a way that didn’t generate meaningful determinations.
The DWS scenario has bought forth a variety of issues that ESG reporting and disclosures are riddled with including:
A major challenge lies in verifying the credibility of the reports since most of the ESG disclosures are self-reported, resulting in a lack of transparency and objectivity. This results from a lack of real-time information and limitations in data accessibility, among others. Observed, third-party data in this regard is essential to fill this existing gap.
With ESG factors being conflated, averaging the scores leads to unclear and distorted results. An analysis carried out by Ernst and Young of 62 asset managers globally in this regard showed that most managers use several different service providers to meet their ESG data requirements, with some managers even hiring up to 10 third-party vendors.
The lack of standardisation in data metrics and frameworks also poses a considerable challenge. Currently, over 600 ESG reporting provisions are being used to analyse datasets. This results in a lack of verifiability and interoperability, making it challenging to verify ESG scores.
Processing large volumes of data is a colossal task which requires several unique data points and is an extremely time-intensive process.
Anthony Kirby, a senior leader at Ernst and Young, in this regard, stated that "Data remains the sector's greatest challenge" for asset managers.
Geospatial Data as a Solution
Geospatial data holds tremendous potential in offering solutions to the data problem. New data sources such as satellites and drone imageries can provide objective data which can replace the self-reported data as well as the ESG scores that currently exist. This can help evaluate the performance of a company against ESG factors. In addition, it has the ability to address the various challenges besetting traditional monitoring systems such as IoT monitors, which are expensive and time-intensive.
However, while geospatial data presents itself as a near-perfect solution, it requires sophisticated models to cull out useful insights from its raw form. Organisations with strong analytical skills and computational capacity play an important role here in consolidating the valuable data from various sources and disseminating them through APIs.
Accurate and responsible ESG reporting goes beyond just being an ethical practice and response to living through a climate emergency but also offers several benefits to one's business. For example, following strong, sustainable principles can help a company make optimal investment decisions. It can help in steering clear of investment choices that have an uncertain future due to regulatory shifts, as was in the case of single-use plastic which got banned across countries.
In addition, experts also believe that stakeholders who consider ESG criteria in their investments are likely to face better risk management. This is because ESG-compliant companies tend to face lower costs of capital and lower risk premium owing to their transparency. Reputational risks, specifically in the investment fund and pension sector, could be detrimental to the business.
The sustainable product and service market is also rapidly expanding as consumers are increasingly conscious of making sustainable choices. In this regard, Nielson's Global Corporate Sustainability Report revealed that about 66% of consumers were willing to spend more if the product came from a sustainable company. This percentage was higher with millennials, with 73% of respondents willing to pay more. Thus, a clear financial benefit is attached to being more environmentally conscious.
Considering these factors, the market for ESG investments has expanded. Bloomberg Intelligence, in this regard, estimated in 2021 that the global market for ESG investment products will exceed $50 trillion in the coming five years.
Likewise, the EY Global Institutional Investor survey reveals that the interest in ESG by financial institutions' is practically universal. As the global momentum toward climate action is increasing, the ESG investment sector is expected to rapidly expand in the coming years. The role of objective data in this transition will thus be paramount.