What is greenwashing, and how to identify it?

What are some of the limitations of ESG?

While the use of Environmental, Social, and Governance factors is a legitimate and important strategy for companies and investors to manage a wide range of risks and take advantage of opportunities, there have been instances of companies, investment managers, and others in the financial industry getting caught making false, exaggerated, or misleading claims on these issues. 

This can happen, for example, with companies making “greenwashing” claims about their environmental practices, but this also happens with exaggerated claims on social and governance issues as well. Greenwashing is the practice of making misleading or unsubstantiated claims about the environmental benefits of a company’s products, services, or practices. This also applies to financial products like investment funds branded as ESG funds. As interest in responsible investing has grown, some companies have exaggerated or misrepresented their environmental efforts in order to attract investment or customers’ interest.

Is greenwashing illegal?

Some greenwashing and ESG-washing is already illegal, as the case against German fund manager DWS pursued by the U.S. Securities and Exchange Commission (SEC) shows. But the current rules also leave a lot of room for interpretation about what products can be branded and marketed as ESG, causing a lot of confusion amongst consumers and investors. For example, many investors may be surprised to learn that Amazon tends to be among the largest holdings in funds that are labeled as ESG-aligned, even though it has come under fire for its harmful labor practices, high greenhouse gas emissions from its suppliers and sellers, predatory pricing, and other issues. 

Investors may also be surprised to learn that asset managers often do not direct the votes corresponding to the shares of public companies that are part of ESG funds in favor of shareholder proposals dealing with ESG issues, like workplace safety, racial equity, and greenhouse gas emissions.

The SEC is taking steps to bring more clarity and investor protection to ESG branded products. For example, in September 2023, it made changes to its Investment Company Act “Names Rule” to address misleading fund names and crack down on greenwashing. Under the amended rules, funds that market themselves with a thematic investment focus, such as the incorporation of one or more Environmental, Social, or Governance factors, will need to invest at least 80% of the value of their assets in investments consistent with that focus and perform quarterly reviews to ensure that assets remain in compliance with that focus. The SEC has also proposed a rule to increase disclosures of ESG branded funds. The rule has yet to be finalized.