On December 7, 2023, presenter Pedro Matos discussed “Greenwashing & ESG Investing at a Crossroads”. The lecture was moderated by Janet Gao.
Pedro’s slides from the lecture can be found here and the Q&A can be found below.
[1] Do you see “green-hushing” becoming more popular in the US in the near future? Do you view this as a hinderance to the prevalence of ESG investing in the US or will it actually help push ESG/Sustainability initiatives in a region where ESG is highly politicized?
In my lecture I focused on “green-washing” (exaggerating ESG commitments) by some US investors and this could undermine trust on whether ESG is sincere and fuel some anti-ESG backlash. I am speculating now but these reactions could lead to “green-hushing” (i.e. investors choosing not to publicize their ESG efforts) or pulling out of ESG initiatives (such as Vanguard’s withdrawal from the Net Zero Asset Managers initiative in December 2022). Both green-washing and green-hushing undermine the effectiveness of ESG investing but I think this scrutiny can be an opportunity for regulatory efforts to establish better ESG standards, reporting and checks. All this is still unfolding but, in the long-term, perhaps it can ultimately strengthen the credibility and effectiveness of ESG initiatives?
[2] Is ESG integration better aligned with risk mitigation than traditional positive and negative screens? If so, is ESG integration better suited to help support the argument that ESG and sustainability is material and integral in generating “alpha” in various investment vehicles. Lastly is it safe to assume that materiality and ESG strategy adoption positively correlated?
That’s a hard question to answer given some of the data limitations of the PRI reporting framework. In our paper “Do Responsible Investors Invest Responsibly?” (https://academic.oup.com/rof/article/26/6/1389/6711405). we find that PRI signatories report more frequently “integration” than “screening”. But we couldn’t separate these using the PRI reports as the approaches are not mutually exclusive and many institutions report implementing multiple ESG strategies simultaneously. One could speculate that integration helps focus more on material ESG issues that can mitigate risks (or possibly even generate “alpha” while these risks or opportunities are not properly priced by the market). Unfortunately, we didn’t have the right data to answer this question.
[3] Are the emission numbers accurate given company emission disclosure is voluntary?
This is a valid concern, however, companies are increasingly under pressure to report accurate data on greenhouse gas (GHG) emissions due to initiatives like the Carbon Disclosure Project (CDP) which I showcased in my lecture. Companies do so in annual reports, regulatory filings, social responsibility reports, etc. as well as by responding to the CDP questionnaires. While reported Scope 1 GHG emissions (from operations that are owned or controlled by the company) are more reliable, it does gets trickier for Scope 2 (from consumption of purchased electricity, heat or steam) and even more difficult for Scope 3 (from upstream supply chain and purchased materials as well as emissions inherent in the use of its products and services). However, there are standards to measure and manage GHG emissions such as the GHG protocol (https://ghgprotocol.org/about-us) which is the framework used by a large majority of the firms that respond to CDP. Increasingly, companies also use third-party verification services to assure their emissions data (https://www.cdp.net/en/guidance/verification). In the absence of company disclosure, one can use other metrics of business activity, sector and geography to come up with emissions estimates (in the study we used those from S&P Global Trucost – see more details in https://www.spglobal.com/spdji/en/documents/additional-material/faq-trucost.pdf – but there are several other data providers). Finally, there are also some interesting independent tracking initiatives – a recent one is Climate TRACE (https://climatetrace.org/about) which uses data from satellites, sensors and additional sources of emission information. So investors are increasingly able to triangulate corporate GHG emissions with multiple sources.
[4] Is there a clear and uniform definition and classification of investor’s greenwashing?
Given the very nature of greenwashing it is difficult to have an exact definition. I am aware of some efforts by the European Supervisory Authorities to put forward a common high-level understanding of greenwashing. A report by the European Securities and Markets Authority (ESMA) defined it as “a practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services. This practice may be misleading to consumers, investors, or other market participants.” (https://www.esma.europa.eu/press-news/esma-news/esas-put-forward-common-understanding-greenwashing-and-warn-risks). However, this is not a legal definition and there have been negative reactions from industry which argued that enshrining it in legislation can be counterproductive.
[5] Would the inclusion of scope 3 emissions address the problem that listed companies account for only 1/5 of the global CO2 emissions?
Yes, that’s a good point. Similar to many other studies, the research I mentioned in my lecture focuses on Scope 1 GHG corporate emissions (from direct operations). We come to the conclusion that, in aggregate, publicly-listed companies account for only 1/5 of the global CO2-equivalent emissions (CO2-e). Just to reiterate the numbers in our study (“Decarbonizing Institutional Investor Portfolios: Helping to Green the Planet or Just Greening Your Portfolio?”, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4212568 ), the sum of scope 1 emissions by listed companies covered by S&P Global Trucost grew from 10 to about 15 gigatons per year during our sample period (while the total net anthropogenic emissions estimates from UNEP went from around 50 to 55 gigatons of CO2-e per year). However, the bulk of GHG emissions in many industries come from scope 2 and 3 indirect sources (both upstream and downstream) and this would indeed represent a significant part of the missing 4/5 of aggregate emissions but I don’t have a good estimate. We tried adding scope 1 + 2 + 3 emissions in some of the tests in our paper but there are important caveats with this analysis. First, these are often not consistently disclosed and the boundaries to measure Scope 3 emissions are not well-defined. Second, at the portfolio-level there are also methodological complexities, such as double counting of the same emissions by multiple supplier/customer public firms across the same supply chains (which we ignored). More research should be done on these issues.
[6] Is it appropriate to penalize investors for greenwashing?
I was unsure how to properly interpret the question but will attempt to answer it two ways depending on who is being referred to as the “investors” in the question. (1) if by “investors” we mean “investment managers” then their clients or beneficiaries can punish such greenwashing through divestment, boycotts, or even protests. In addition, in my lecture I gave examples of investment managers (such as DWS, BNY Mellon, Goldman Sachs) that paid fines or agreed to penalties from regulators such as the U.S. SEC. However, if (2) I read the question as labeling the “investors” the actual current clients or beneficiaries in these investment funds. In that case, when their investment managers pay fines or suffer other penalties for greenwashing this might impose costs to the current “investors” (at least partially if investment managers pass-through those costs to the current clients or beneficiaries). So investors may actually be funding these penalties which is what is sometimes argued to be the case for securities fraud class action suits (where the earlier “harmed” investors that are suing take money from later investors).
Pedro Matos is the Academic Director of Mayo Center for Asset Management, holds the John G. Macfarlane Family Chair and is the James A. and Stacy Cooper Bicentennial Professor of Business Administration at the University of Virginia Darden School of Business. His research focuses on the growing importance of institutional investors worldwide. It has been published in leading academic journals as well as monographs for the CFA Institute and featured in the press, including in The Economist, Financial Times, The New York Times, Bloomberg, etc. and received numerous research awards. He is a Research Associate at the European Corporate Governance Institute (ECGI) and a member of the UN-sponsored Principles for Responsible Investing (PRI) Academic Network Advisory Committee. He previously taught at the University of Southern California and holds a Ph.D.in Finance from INSEAD.
For further information on the webinar please contact Professor Jun Yang, Director of the Institute for Corporate Governance at icg@indiana.edu.
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