ESG space should welcome the regulatory spotlight

Support from corporate executives and slick marketing is no match for rules and regulation when it comes to managing sustainable portfolios.

Despite the best efforts of the most dogged proponents, ESG investing has always operated in or near the thickets just off the beaten path of mainstream financial services, so it isn’t all that surprising to see another messy dust-up emerge.

But this latest example, involving charges of greenwashing at DWS Group, has drawn the attention of regulators on two different continents and could ultimately represent a major milestone in the evolution of the increasingly popular environmental, social and governance investing landscape.

Greenwashing, for the uninitiated, is the colloquial term for companies and investment strategies being presented as more ESG than they actually are to tap into the flood of investor capital moving into the general category.

In the ongoing case of DWS, it appears a whistleblower exposed some gaps between what the asset manager was promoting on the green front and what the underlying portfolio managers were doing.

While the practice of greenwashing has probably been around in some form since shortly after sustainable investing gained its first buck, the DWS example is significant because it is colliding with a few other forces that are bound to draw regulatory scrutiny to an area that desperately needs clarity, structure and transparency. That is something the ESG space should be celebrating, but like many stages of progress this one might not look and feel like a good thing at the moment.

“DWS is one of the world’s largest asset managers and this is a watershed moment,” said Alexandra Mihailescu Cichon, executive vice president at RepRisk, the Zurich-based ESG data provider.

“Everyone is suddenly paying attention,” she added. “Now the stakes are very high for asset managers and asset owners, and for data providers.”

SPILLED THE BEANS

While it might be easy to shrug this all off as inside baseball, especially since the concept of greenwashing is nearly as undefined as the general concept of ESG investing, the increased interest from regulators sheds light on a broader deliberation over whether corporations can effectively police themselves in a way that does any good for the planet Earth or its inhabitants.

That point was underscored with gusto in August when a former chief investment officer for sustainable investing at BlackRock spilled the beans from inside the world’s largest asset manager in series of three lengthy essays essentially calling on regulators to do what companies competing for profits will never be able to do on their own.

After spending the better part of two years flying around the world on private jets with BlackRock CEO Larry Fink to promote the virtues of sustainable investing, Tariq Fancy went full Jerry Maguire as it sunk in that BlackRock and virtually every other asset manager had to follow a single operating principle: “You can’t forego profits with someone else’s money.”

Also included among Fancy’s nuggets of insight that would take an efficient reader at least four hours to digest, “If ESG information was truly useful, (portfolio managers) would use it without being asked.”

Fancy relies heavily on basketball analogies to make a point about the ultimate scoring impact when sportsmanship is considered and how the pursuit of scoring points is only limited by established rules, and sometimes by getting away with breaking those rules.

He credits Fink with drawing attention to and setting the sustainable investing bar for corporate executives through his 2018 annual letter presenting the idea that “successful companies needed to serve a social purpose.” But Fancy also delivers a succession of gut punches describing much of the ESG efforts as aggressive marketing that is often disconnected from portfolio management.

Fancy, who transports the reader on an enlightening adventure through his upbringing, education, background, personal motivations and even cocktail parties, applies several factors including politics, time, capitalism and human nature as reasons sustainable investing will have very little impact without regulations that force measured and guided participation.

“If we change the rules of the game, we’ll get different outcomes, all of which can be described as market outcomes,” he writes. In order “to fix the system, we need governments to fix the rules.”

OUT OF THE THICKETS

Meanwhile, Cichon of RepRisk agrees with Fancy regarding “government’s role in creating clarity and comparability in the ESG landscape.”

But she believes Fancy is not giving enough credit to market forces and “some of the good work that has been done in the absence of government regulation.”

“When governments were not acting over the last 10-to-20 years fast enough and clear enough on ESG issues, plenty of players in the market tried to do something meaningful and impactful, albeit imperfect, and the current debate around greenwashing somehow seems to discount a lot of that,” she added. “No, it wasn’t good enough or fast enough, and the current scrutiny in the current regulations will separate those that are doing something from those that are just talking about something. But let’s not throw the baby out with the bath water.”

If the Securities and Exchange Commission’s recent proposal for mutual funds to provide more transparency around proxy voting procedures is any indication, the bath water and the baby will eventually be handed over to regulators for more oversight.

As difficult as it might be at first, this will hopefully be the beginning of what the ESG space desperately needs to pull the category out of the thickets for good.

In many ways, ESG proponents should be celebrating a transition toward increased regulatory oversight on how and where all that marketing muscle starts to get measured against actual portfolio management in an open arena with universal rules, boundaries and referees.