Former BlackRock executive blows the whistle on greenwashing

Fear of missing out on fund flows gives asset managers a strong incentive to pretend all their offerings are green.

WITH so much money flowing into securities deemed compatible with environmental, social and governance (ESG) standards, the risk of asset managers disingenuously promoting their offerings as being ESG compliant is high and rising.

Unfortunately, new European Union rules designed to delineate the industry's performance will likely lead to more greenwashing, not less.

Last week, Tariq Fancy, the former chief investment officer for sustainable investing at BlackRock, the world's biggest asset manager overseeing US$8.7 trillion, castigated the industry's duplicity, in an article for USA Today:

"In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community. Existing mutual funds are cynically rebranded as 'green' - with no discernible change to the fund itself or its underlying strategies - simply for the sake of appearances and marketing purposes."

The numbers back him up. According to data compiled by Morningstar, more than 250 existing European funds changed their investment objectives to adopt an ESG stance last year, with almost all of them rebranding to reflect the purported change.

Color me sceptical: With ESG funds pulling in almost 100 billion euros (S$159 billion) of new money in the fourth quarter, which Morningstar reckons was 45 per cent of total fund inflows, the temptation to stick an ESG badge on all funds is proving irresistible.

Earlier this month, the EU introduced the Sustainable Finance Disclosure Regulation, a suite of rules aimed at policing how the fund management industry deals with the climate emergency.

The aim is laudable; but the law of unintended consequences means the attempt at codification is likely to backfire.

The new rules basically create three classifications of European funds. One category - Article 9 in the taxonomy - is designed to encapsulate what are commonly called impact funds, where the objective is to proactively allocate capital to projects such as renewable energy or health care or clean water.

Also dubbed "dark green" investments, these comprise the smallest and most intensive category of ESG products.

The second designation - Article 8 - covers the remaining "light green" ESG suite, or funds that have "environmental or social characteristics". That would cover products that exclude some securities based on their environmental unfriendliness or other criteria deemed unacceptable.

The rest of the fund universe should fall into the Article 6 grade, designed to encompass investments that ignore any and all of the criteria that their ESG brethren take into account when deciding what to buy.

But there's a problem. In the current investing climate, there's absolutely no incentive for a salesforce to pitch an Article 6 fund to a customer. Asset allocation committees want to be seen doing the right thing, so any funds that are not explicitly ESG-friendly effectively become market pariahs.

This creates a strong temptation to classify all funds under Article 8, even if they're measured against non-ESG benchmarks and their securities selections don't take such concerns into account.

David Czupryna, the Paris-based head of ESG development at Candriam, which manages about US$143 billion in assets, says that the aim of the three-pronged classification, and the accompanying rules on mandatory disclosures, was to "dissuade would-be half-hearted ESG asset managers from emphasising sustainability".

By setting a high enough bar for Article 8 and 9 funds, only truly sustainable portfolios would qualify.

However, fear of missing out on the cash flowing into green funds can also incentivise playing fast and loose with the rules.

Mr Fancy, the former BlackRock executive, argues that the marketing efforts of the asset management industry are "a placebo" for addressing the climate crisis and shouldn't replace government action.

"A 'free market' will not correct itself or fix the problem by its own accord," he wrote.

It would be a shame if the EU's genuine attempt to impose some order on the green funds landscape, which is currently a bit of a Wild West, backfires.

But as Huw van Steenis, the chairman of sustainable finance at UBS AG, wrote for Bloomberg Opinion recently, the bloc's methodology is both too strict and too broad, excluding some investments that should be deemed green as well as firms that are becoming more carbon neutral.

Given that every asset manager claims to have ESG at the heart of their investment process these days, they can claim to qualify as Article 8 under the new taxonomy.

People seeking to do no harm with their cash will need to be even more vigilant in ensuring their funds are really as green as they say they are. BLOOMBERG

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