Will the Real ESG Leader Please Stand Up?

DWS, the asset management unit of Germany’s largest banking institution, Deutsche Bank, was recently raided by 50 agents of the German law enforcement authorities. Why? It is alleged that it committed fraud by falsely advertising its so-called ESG investment portfolio.

Desiree Fixler, who was chief sustainability officer at DWS and was fired recently, alleges that DWS misrepresented its ESG investment portfolio when it published that over half of the group’s USD 900 billion assets were invested in ESG-friendly companies. The fact that DWS’s CEO, Asoka Woehrmann resigned soon after the raid, reportedly to ‘clear the way for a fresh start’, indicates that there might be significant truth to the allegations.

The DWS case is also not one in isolation. Recently, American investment banking services holding company BNY Mellon was fined USD 1.5 million for ‘misstatements and omissions about its ESG considerations’; Earlier, the U.S. Securities and Exchange Commission (‘US SEC’), the American government’s market manipulation watchdog, had charged Brazilian mining company, Vale, for misleading investors on safety prior to a deadly dam collapse.

The big cheeses of the corporate world can be seen spending millions of dollars on advertisements to prove that their products are environment-friendly. Terms like “organic”, “100% pure” and “eco-friendly” are callously tossed in with luring commercials comprising lush green grass and picture-postcard scenery.

The question that needs to be addressed here is why would a company feel the need to falsely advertise about how socially responsible its investments are? To understand this, one needs to study the development and growth of ESG. ‘ESG’ has been the new favourite buzzword with investors and some upmarket consumers, and therefore makes way as the top agenda in most boardroom discussions.

‘ESG’ stands for ‘Environmental, Social and Governance’ – the three areas which are key for all socially responsible investors and consumers. According to a recent report by professional services network PwC, 83 per cent of consumers think companies should be actively shaping ESG best practices, 91 per cent of business leaders believe their company has a responsibility to act on ESG issues, and 86 per cent of employees prefer to support or work for companies that care about the same issues they do. This has led to an increased pressure on the company to seemingly look ESG-friendly, and they have knowingly or unknowingly given themselves to the practice of greenwashing.

It can be easy for companies to evade their social responsibility and still be seen as socially responsible, if there are no strong guidelines and metrics on ESG.

The 2021 United Nations Climate Change Conference has also significantly influenced ESG discussions, especially on the ‘E’, and more specifically on climate change. Climate change is a legitimate concern, and the new claim to fame for corporate entities is organizing and supporting related campaigns. The greener the stance, the better the social standing. Therefore, the big cheeses of the corporate world can be seen spending millions of dollars on advertisements to prove that their products are environment-friendly. Terms like “organic”, “100% pure” and “eco-friendly” are callously tossed in with luring commercials comprising lush green grass and picture-postcard scenery. These commercials coax buyers into believing that they can conveniently and actively ‘save the environment’ by purchasing the product.

One can take the example of bottled water brand FIJI Water, which met with a class action suit in the U.S. for its campaigns that marketed FIJI as “the world’s only carbon negative bottled water”. However, a report by American business magazine Fast Company stated that the machinery used to extract the underground water was run on diesel fuel, and producing one bottle of FIJI water uses 1.75 gallons of water and 2000 times more energy than tap water. If these reports even contain half the truth, the company is still a light year away from being carbon-neutral.

Also read: Vedanta’s serial crimes against Indian people, land and water expose State-Corporate nexus at its worst

E.U. and the U.S. are already policing ESG

Greenwashing is becoming more challenging to recognize as investors and portfolio firms grow more concerned about ESG issues. For example, the E.U. taxonomy for sustainable activities aims to reign in greenwashing by defining what is and isn’t sustainable. However, some are concerned that poorly constructed regulations would make it easier for companies to advertise their goods as environment-friendly by merely ticking the boxes.

A recent example would be the ousting of Tesla, the world’s largest electric vehicle manufacturer, from the S&P Sustainability Index, which has invited a lot of criticism. It would perhaps not have been this controversial, had it not included ExxonMobil into the list, a multinational company whose business relies entirely on oil and gas exploration. This shows how easy it can be for companies to evade their social responsibility and still be seen as socially responsible, if there are no strong guidelines and metrics on ESG.

To keep up with this new development, regulatory authorities are working hard to implement new rules. Europe’s Sustainable Finance Disclosure Regulation, which came into force on March 10, 2021, tries to bring in a binding and transparent framework for assessing sustainability risks and defining what constitutes Sustainable Finance.

On the entity level, it requires financial market participants to publish information on their sustainability practices and the financial products they provide (for example, asset managers, pension funds, and so on) (product level). Sustainability risks must be included in a company’s investment portfolio, indirectly influencing countries outside the European Union.

For all investors or companies, an ESG policy is the new strategy to win over the market

The US SEC also recently introduced a proposal to amend certain rules to provide greater transparency to investors about ESG factors in certain investment products, especially for those investment funds marketing themselves as having ESG-focussed strategies.

Time for India to step up its ESG policing measures?

Due to the emerging ESG mandate, investors will demand more explicit and standardized ESG disclosures from the Indian firms they invest in. As a result, Indian companies with a global clientele are now looking for effective social and environmental initiatives to adorn their policies.

Earlier this year, it was reported by The Guardian that Shahi Exports, which is India’s largest garment exporter and supplies to worldwide clothing companies of the likes of H&M, GAP, Nike, Adidas, and Ralph Lauren, among others, agreed to pay GBP 3 million of unpaid wages to its workers, after two years of reluctance. This payment isn’t because of a court order, but because of the increased pressure international brands which were sourcing from Shahi and other such manufacturers were receiving, because of their lack of accountability for payment of legal wages to workers in their supply chain. Naturally, this had a trickle-down effect, and we can soon expect Shahi and other manufacturers to compensate workers with unpaid wages, with or without court orders.

Also read: Centre ‘fails to pay’ Rs 74 crore to Andhra rural workers: MGNREGA wage transfer delay

We have also seen India’s market regulator, the Securities and Exchange Board of India, getting active in this sphere. It has suggested several disclosures in Scheme Information Documents (SID) to guarantee credibility, transparency, and accountability in the strategy used by the companies, with relation to sustainability or ESG features. Under the new Business Responsibility and Sustainability Report (‘BRSR’) reporting regime, companies need to disclose their ESG risks and the mitigation strategy for such risks. The financial implications and sustainability goals also have to be reported.

The disclosure model has been suggested to ensure that India is at par with the prevalent international standards. Therefore, for all investors or companies, an ESG policy is the new strategy to win over the market.

Also read: Welcome changes to SEBI (Alternative Investment Funds) Regulations, 2012 but bottlenecks remain

While the BRSR is mandatory only for the top 1,000 companies by market capitalization in India, regulators need to actively watch out for other businesses and investors who are doing the talk about being ESG-focused. With the increase in market awareness and pressure, many businesses may release half-baked socially conscious products to go with the trend, masking certain behind-the-stage truths.