The cost of empty ESG promises
Greenwashing leads to climate litigation – and finance is on the firing line
Do your words have meaning? Do they hold true value? Is there an implied truth that adds weight to them or are your words just for effect without any meaning for tomorrow? Greenwashing is becoming a major problem in the corporate world and is inhibiting investment in new technologies and companies. In society, we try to protect commitments that have been made to us with contracts, laws, agreements and enforcement. However, building trust is a much better way of protecting ourselves and needs to be established at the very start of our interactions with another party when we need to make judgements on our counterparty’s character and assess how much we can count on the authenticity of their commitments to us.
There is an increasing focus in the climate change debate on the issue of trust – that the words said or promises made by corporations, governments, states, regulators and even individuals have to be accurate, reliable, verifiable and to mean something to investors.
How can we ensure that people are true to their word so we can create a modern society where words carry value again, greenwashing is eradicated and investment dollars flow to where they are most needed?
Holding corporations to account
Regulators and consumers are reading corporate sustainability disclosures with increasing care. As a result, more and more companies are being caught up in litigation provoked by their disclosures. Recent examples have involved companies as diverse as Vale, BP, Volkswagen, Facebook and Kmart. Investors are increasingly liable to challenge misleading information, either through shareholder pressure, exercising influence over boards or via regulators. People are holding their governments and corporations to account, challenging the non-enforcement of climate-related laws and policies. Climate litigation is a key factor in efforts to compel governments and corporate actors to deliver on their climate change commitments. September's launch of the #SeeYouInCourt campaign by the International Federation for Human Rights – a federation of 192 human rights groups in more than 100 countries – is part of organised litigation action against polluting businesses.
This is a subject corporate boards and their legal advisors need to pay attention to. It raises the stakes significantly on all forms of public pronouncements on sustainability, increasing the risks on multiple levels if statements are not supported by validated facts.
Words have to stand up to scrutiny, and that means avoiding contradiction. Putting aside the issue of greenwashing, companies cannot make a statement in one area of their business about sustainability but act in a contradictory way elsewhere. This is where words carry more weight than legal contracts and agreements. This is about the spirit of words, and where the scrutiny of others is a powerful deterrent to misstatement.
Banks are particularly in the firing line. Those that have joined the Glasgow Financial Alliance for Net Zero are very vulnerable. Unsurprisingly, the discovery that some of them still grant loans to coal companies led to a furore among many environmental groups.
Stakeholders that favours green products want to believe in the ethics of their bank; this type of inconsistency erodes trust. Aligning a loan book with a bank’s environmental commitments is incredibly complex, but more effort needs to be made to make sure that words are matched by actions.
A new joint UK and Task Force on Climate-Related Financial Disclosures proposal made at COP26 is expected to widen the scope of mandatory climate financial disclosure. It seeks feedback on TCFD disclosures from asset managers, life insurers and pension providers. Global regulatory authorities are also requiring increasing detail from asset managers on the sustainability claims they make in their fund fact sheets, prospectuses and advertising materials. They are demanding detail and depth. One recent IPO filing by an undisclosed energy company was postponed by the Australian regulatory authority due to lack of proper disclosure regarding net-zero carbon emissions statements. The focus on matching words and deeds is intense.
Data comparability is key for investors. The investment due diligence process is improving, and inconsistencies and data verification are increasingly likely to reveal misstatements. In 2018 the State of New York sued Exxon Mobil, accusing it of stating one proxy cost of carbon publicly but applying another in internal guidance, and applying no proxy cost at all to some of their reserves – therefore, misrepresenting the risk their company faces even under the unlikely scenario of 2C warming. The courts found no wrongdoing but a similar case against the oil giant in the state of Massachusetts is pending.
Comparable risks apply to corporate advertising campaigns, although the challenge to companies will primarily come from activist or environmental groups, rather than from regulatory agencies. Misrepresentation on the scale of transition to renewable and low-carbon energy by resources corporations is a particular target for activists. Advertising campaigns that create a greener look and feel than reality are increasingly leading to private legal action.
It is important that corporations and financial institutions build necessary environmental, social and governance resources and revise their governance arrangements to include appropriate ESG oversight at the board level. There are ways of achieving this. For example, a company we have studied, ARCH Emerging Markets Partners – a London-based private equity advisory business – commissions independent consultants to assess ESG risks and opportunities of potential investment against the international ESG standards. ARCH has launched a fund that focuses on metals and their contribution to decarbonisation and electrification of global economies, and does not rely on ESG ratings or company disclosures, publicly or otherwise, during its due diligence review process. We found this approach sensible. We also observed that ARCH’s portfolio companies are expected to take responsibility for establishing controls to meet their ESG obligations, include ESG criteria in company remuneration policies, and make annual public ESG disclosures on the Digbee ESG platform, which focuses on the mining sector and is subject to independent assessment and scoring.
Saying one thing and doing another can result in practical consequences, like the stalling of infrastructure projects because of non-alignment with the Paris Agreement or time-consuming commercial disputes. Companies need to take more care to check the accuracy of their statements, be more cautious in their environmental claims and conduct proper impact analysis of their business activities if they really intend to walk the ESG walk, and not just talk the talk.
Nouriel Roubini is the CEO of Roubini Macro Associates and the co-founder of theboombust.com; Paul Smith, is the founder of SustainFinance and the former CEO of the CFA Institute; Kübra Koldemir is a business writer at not-for-profit SustainFinance and a sustainability researcher at Argüden Governance Academy.