Greenwashing – the practice of exaggerating your environmental, social, and governance (ESG) credentials, both to attract more investment dollars and to hide the reality of poor ESG performance – has become increasingly problematic in the investment world. Eugenia Unanyants-Jackson, the Global Head of ESG at PGIM, the investment management business of Prudential Financial* with over $1.2 trillion in assets under management, recently published a white paperon ESG and greenwashing. Last month, I sat down with her to discuss greenwashing, ESG strategy and goals, subjectivity, trade-offs, shielding poor economic performance, and ESG-related commitments.
Unanyants-Jackson argues that more greenwashing is occurring because there is “a strong commercial imperative for investors to move more of their assets into some kind of ESG focused strategies.” There is also a rising “perception” of greenwashing, based on ESG’s subjectivity in its definition and expectations, that has made developing investment strategies more difficult. It is therefore critical for asset managers to understand an investor’s objectives and determine which strategy to use to reach their goals. Unanyants-Jackson described two ways that ESG can add value for investors. The first is by using a strategy that “manages investment risk and helps identify investment opportunities which arise from ESG factors.” These risks appear when analyzing the data regarding a company’s poor performance on ESG factors such as those related to climate, workforce, and corporate-governance practices. An ESG analysis allows an asset manager to identify those risks and may create opportunities that otherwise would have been missed.
The second way for ESG to create value – albeit value not necessarily captured by investors in financial returns – is by helping investors “generate environmental and social benefits … alongside financial returns.” While this second aspect is not mainstream, it is growing globally as investors increasingly express their desire to have an “impact.” However, it also adds to the complexity of ESG, given the subjectivity and heterogeneity in desired impact strategies. Some investors care more about climate change, while others are more focused on workforce development. These sometimes-conflicting objectives become more difficult to achieve when investors have different time horizons or expected risk-adjusted returns for their investments. Therefore, Unanyants-Jackson argues that ESG should be “definitely not one size fits all, [rather] it’s 1,000 sizes . . . to fit millions of different needs.” It has also meant that companies are increasingly using greenwashing to fit the growing list of investor needs. Furthermore, while ESG is criticized for being too subjective, she argues that “all investing is subjective and in fact the capital markets function better as a result.”
The positive rationale Unanyants-Jackson sees in regard to ESG’s subjectivity also applies to ESG ratings and rankings. She argues this is why there’s a “very low correlation among different ESG ratings.” Raters and rankers “weigh different issues in different ways . . . [with] very different objectives.” However, even the best-known raters still focus on ESG “risk and opportunity.” This is why a company’s high ESG rating still means a low ESG risk. However, a “low ESG risk doesn’t mean necessarily [a] positive impact on the environment or society.”
However, when ESG goals conflict or when investment returns are equally as important to the investor as other ESG issues, there will need to be trade-offs. Impact investing, for example, has traditionally been thought of as concessionary for the trade-off of higher returns in exchange for a measurable impact. However, according to Unanyants-Jackson, the concept of “impact investing” may be changing because investors are beginning to expect venture capital-like returns. She characterizes these types of investments as “high risk and high reward,” but with a solutions-based approach to sustainability issues.
Excluded sectors such as those that are energy-related are currently outperforming the market, but Unanyants-Jackson argues that this could easily change. Furthermore, ESG investing transcends some of this market fluctuation because it’s part of the “sustainability megatrend.” These megatrends, she argues, can lead to good long-term investment results. However, ESG has become so broad and encompasses so many factors that investment success really depends on the “investable universe, investment style, [as well as] . . . the economic conditions around us.” This ultimately is why it’s so difficult to prove ESG strategies perform better than the broader market, especially through a short-term outlook.
Corporate ESG commitments have recently been a topic of concern for investors, says Unanyants-Jackson. She argues that these commitments are important for raising awareness about climate change, among other issues. Investors increasingly want to see companies set high-level, ambitious targets. There are essentially two approaches to ESG commitments. The first involves setting an ambitious target and providing the necessary resources to create an implementation plan. While these plans can take two or three years to create, if there is no action after that time frame, there would likely be a real cause for concern for investors.
The other option is to create an implementation plan and refrain from declaring any ambitious target until it’s sufficiently put into action. This may well become the preferred option if the SEC’s proposed climate-disclosure rule is implemented, given its disclosure mandate regarding targets. Under the SEC’s proposed climate disclosure rules, targets would have to be listed, explained, and filed with the SEC. Regardless of which approach is adopted, improving the quality and availability of data to investors is vitally important. Without proper data on targets and plans, asset managers would be forced to make assumptions about the viability of an issuer’s climate-related targets and plans for their investment decisions. In addition, while Unanyants-Jackson acknowledges an increased use of ESG goals to shield poor economic performance, active investment managers are typically able to decipher this by analyzing the data.
International commitments have also been championed as progress toward addressing the risks of global climate change. Unanyants-Jackson argues in support of these types of commitments, such as those made through the Glasgow Financial Alliance for Net Zero (GFANZ) at COP26 to accelerate the decarbonization of the economy.
Recently, however, these commitments have come under scrutiny because of the impact of world events and the U.N.’s “increasingly stringent” decarbonization commitments. Both have led some to reassess their GFANZ membership, including some of the world’s largest banks, which have threatened to pull out, citing increased litigation risk and anticipated U.S. congressional oversight. In addition, a group of U.S. senators sent a letter to more than 50 of the largest law firms raising concerns about antitrust issues surrounding these types of commitments. A day later, GFANZ indicated that it would allow its members to drop their commitment to phase out fossil fuels, citing antitrust concerns.
What was abundantly clear from our discussion is that greenwashing, or “ESG washing,” will continue to have a significant impact on ESG-related discussions. Whether greenwashing is used to hide a poor environmental record or low ESG rating, to shield a company’s economic performance, or to minimize ROI “trade-offs” in certain ESG investment strategies, it is likely that both Democrats and Republicans on Capitol Hill will be closely monitoring its increased usage.
* Prudential Financial is a member of the Bipartisan Policy Center.
Timothy M. Doyle is a Senior Advisor at the Bipartisan Policy Center in Washington, D.C.
