Are we green yet?

In 1970 Nobel laureate economist Milton Friedman wrote “there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits”ⁱ.

Fast forward to the present day, businesses must think and manage their way around many salient social issues that broadly fall under the ESG umbrella. Especially pressing now is the need for real and transformative climate action from businesses to help tackle the climate and biodiversity crises in which we find ourselves. Whilst Friedman’s view on corporate social responsibility now seems outdated, he was right to point out that many businesses couching their actions in moral rhetoric were being deceptive, so-called ‘greenwashing’ in today’s terms.

Corporate greenwashing can be described as the practice of deliberately or unintentionally disseminating distorted or unsupported claims that promote a positive environmental image around the company’s products, business strategies or actions. Through greenwashing companies could positively differentiate themselves, so to boost brand image and increase sales, but at the same time fail to honour their outlined environmental commitments. Greenwashing erodes the trust of investors and consumers, fuels cynicism and creates the false perception that critical problems are being tackled, when they are not, potentially having an adverse effect on the intended outcome.

A 2021 review of the UK Competition and Markets Authority across c500 corporate websites found that c40% of green claims made by marketing materials were exaggerated or deceptiveⁱⁱ. This high percentage suggests that companies believe they will not be held accountable for their green claims. Although consumer law can be used to upheld honesty in green advertisement campaigns, there is still no regulation, like that for financial statements, to monitor greenwashing in corporate ESG commitments, carbon disclosures or net-zero pledges. Most environmental data released by companies is unaudited and often voluntary. Due to the variation in the quality and content of data, it is challenging for investors to assess risks and opportunities related to sustainability and climate for individual companies and to incorporate these into the asset management process. At COP26 the International Financials Reporting Standards (IFRS) Foundation announced that it is in advanced stages of creating a set of global sustainability disclosure standards to provide more transparent and comparable ESG data to investorsⁱⁱⁱ. A newly established committee, called the International Sustainability Standards Board (ISSB), will sit alongside IFRS, and will oversee the sustainability disclosure standards. Nevertheless, widespread adoption of the new standards will take time as companies will only be required to comply once the standards have been adopted by national regulators.

Investors still play a key role in fighting corporate greenwashing. At Evenlode we believe the integration of ESG considerations and risks into our decision-making process can help sustain and improve returns for clients. Through active engagement with our investee companies on climate disclosures and target setting we augment our research, clarify public information, and inform our proxy voting decision. We believe investor engagement and voting is an important aspect in driving more transparent corporate sustainability disclosures and tackling corporate greenwashing. Here we discuss two often overlooked criteria to consider when evaluating corporate environmental claims.

Less Net, more Zero

Over the last years, most major global companies have made pledges on carbon emission reduction with goals of net-zero by 2030 to 2040 depending on the carbon intensity of the business model. Net-zero does not mean a total absence of emissions, modest amounts are still envisaged even under the most ambitious targets as currently there is no realistic way to fully eliminate the use of fossil fuels in industrial processes by 2050. The premise of net zero is that emissions which cannot be reduced are offset - either through reforestation, and carbon capture/storage, or through carbon credits that are bought and sold on a commodities-like market. While the use of offsets can be positive in the short-term by allowing corporations the time to reconfigure their business models to genuinely reduce carbon emissions, it is not an alternative for emissions reduction in the long run.

Businesses have enjoyed significant discretion on setting their paths to net-zero, leading to corporate net-zero targets being called-out as mostly greenwash. In 2020 several US large cap companies were found to be advertising carbon offset projects by funding the preservation of forests in Pennsylvania^iv. However, these forests were already well-preserved and not under threat of being cut. So, the carbon-absorbing effect of the forest would have occurred already even in the absence of funding from the companies.

Science Based Targets Initiative (SBTi) released the first global standard for evaluating corporate Net-Zero targets in Oct 2021. Under the new SBTi standards companies will require deep decarbonization of 90-95% to reach net-zero and only 5-10% of emissions can be offset^v. This provides investors with welcome criteria to evaluate corporate net zero commitments and help distinguish the wheat from the greenwashed. We consider alignment to industrywide standards like the SBTi when we determine an investee company’s ESG risk score and, whenever possible, we encourage companies to adopt the most comprehensive standard for their reporting.

Talking green while lobbying brown

In response to greater scrutiny and pressure from the public, most large global companies have now adopted environmentally oriented images. However, some of the same companies are using lobbying to block or reverse the adoption of markedly better governmental environmental practices. This misalignment of a corporation’s sustainability image from its lobbying activities is also a form of greenwashing.

In 2021, thinktank InfluenceMap reported that key industry trade associations were actively lobbying against efforts to implement the EU climate goals, despite many of the same groups representing companies that are publicly supporting net zero by 2050^vi. Most initial organisations were those from hard-to-abate sectors like energy, utilities and transportation. The Evenlode funds inherently have low exposure to these industries as they tend to not have the financial characteristics that we seek - low capital intensity that generates a high return on assets.

Lobbying potentially represents the biggest impact a company can have on climate change policy. Thus, investors should cross-check a company’s messaging with its lobbying practices. Nevertheless, this form of greenwashing is hard to detect as in most jurisdictions there is no requirement for companies to disclose what position they are lobbying for. A first step could be engaging with the company to secure more disclosures on its climate lobbying practices in an aim to identify lobbying activities that may be inconsistent with the company’s stated climate targets, or failing this, voting against lobbying resolutions at AGMs. The Evenlode Stewardship team engages actively with the companies in which the Evenlode funds are invested and often seeks enhanced disclosures in areas that can provide meaningful information towards our investment decision-making process.

While a lot has changed since Friedman’s article in 1970, there is still much work left to do in order to address the disconnect between business and social responsibility. ESG disclosures and net zero pledges provide a great opportunity to improve a company’s climate and biodiversity performance, but if executed poorly, these can just be a greenwashing exercise. Like with financial disclosures, investors have a duty to hold companies accountable and ask tough questions when companies assert their green credentials. Engagement through regular dialogue is crucial to mitigate the risk of greenwashing in portfolio holdings and to encourage better corporate disclosures and climate policy alignment.

Cristina Dumitru, Investment Analyst
2021

Please note, these views represent the opinions of the Evenlode Team as of 2021 and do not constitute investment advice. Where opinions are expressed, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is not intended as a recommendation to invest in any particular asset class, security or strategy. The information provided is for illustrative purposes only and should not be relied upon as a recommendation to buy or sell securities. Every effort is taken to ensure the accuracy of the data in this document, but no warranties are given.