Investment & philanthropy
This article first appeared on the Practical Law Dispute Resolution blog in August 2022.
The Frankfurt offices of Deutsche Bank and its asset management unit, DWS, were recently raided by the German police investigating claims of greenwashing. Within days, DWS’ chief executive, Asoka Woehrmann, had stepped down and investigations continue in the US and Germany. Right now, this seems to be an extreme example of how greenwashing claims can play out for financial services firms. But, this may be just the start and financial services firms have much to think on in respect of their ESG (environmental, social and governance) responsibilities. In this blog, we consider how greenwashing claims pose a risk in the context of ESG or sustainable funds.
The market for ESG funds has been on the rise for some time. Environmentally and socially conscious investors are looking for credible ESG funds, and financial services firms are keen to accommodate the demand. This trend is borne out in PWC’s 2021 Global Investor Survey, which revealed that almost 80 per cent of investors considered ESG factors to be important to their investment decision-making. However, in PWC’s 2021 Embracing ESG Transformation report, only 46 per cent of asset managers said they were conducting any form of quality assurance work on their ESG data, opening up a real risk of greenwashing allegations.
“Greenwashing” was first coined by the environmentalist Jay Westerveld in the 1980s. It referred to organisations that purported to be environmentally conscious for marketing purposes but were not actually making any significant sustainability efforts. Although no formal definition of greenwashing has been set out by the FCA in its rulebook and no formal definition has been adopted by the EU:
- In a 2018 discussion paper, the FCA noted: “Green washing is marketing that portrays an organisation’s products, activities or policies as producing positive environmental outcomes when this is not the case”, and
- In its recent sustainable finance roadmap, ESMA noted: “The term greenwashing may be defined in a number of ways, but it intuitively refers to market practices, both intentional and unintentional, whereby the publicly disclosed sustainability profile of an issuer and the characteristics and / or objectives of a financial instrument or a financial product either by action or omission do not properly reflect the underlying sustainability risks and impacts associated to that issuer, financial instrument or financial product”.
In more recent times, financial services firms have been accused of greenwashing with allegations that they have exaggerated or misrepresented the ESG credentials of an investment product. Part of the problem is that there is no clear market definition of what constitutes a “green” or “ESG-compliant” investment (or indeed, as discussed above, what exactly constitutes greenwashing). Added to this, industry benchmarks (such as the S&P 500 ESG Index and MSCI ESG Indexes) may use different metrics to rate companies and a company that has ESG credentials on one index, may not be listed on another. Taking Tesla, Inc as a well-known example: Tesla currently has an “A” rating on MSCI’s ESG Ratings but was recently removed from the S&P 500 ESG Index due to corporate governance and health and safety concerns (despite that its self-declared environmental-focused mission is to “accelerate the world’s transition to sustainable energy”). For asset managers using those indices when selecting their investments, the landscape becomes very murky.
However, steps are being taken towards integration:
- Since March 2021, the EU has required certain financial services firms to make sustainability-related disclosures on their websites and the documents of their financial products,
- From 1 August 2022, the EU will require alternative investment fund managers and UCITS management companies to integrate sustainability into their portfolio and risk management processes and overall governance structure, and
- From 2 August 2022, the EU will require financial advisers and distributors to ask clients to specify their sustainability preferences.
In the UK, the FCA last year published a “Dear Chair” letter to the Chairs of authorised fund managers setting out its expectations on the design, delivery and disclosure of ESG and sustainable investment funds. This letter annexed a set of guiding principles to help authorised fund managers apply existing FCA rules when designing, delivering and disclosing ESG and sustainable investment funds.
This year, the FCA introduced a mandatory disclosure regime for financial services firms and products which is in line with the recommendations set out by the Task Force on Climate-Related Financial Disclosures. The FCA is also considering a labelling regime so that consumers are easily able to identify which investment products have ESG credentials, and which products do not. The UK regulator is exploring whether to regulate ESG data providers. All of which should help firms navigate the ESG landscape by creating more clarity.
It is clear that regulators are taking the issue of greenwashing seriously and firms must take care when marketing funds as having “sustainable” or “ESG” or “impact” elements. The failure to market funds accurately may have been one of the issues for DWS. If a fund is unclear as to how ESG factors are analysed, including how ESG factors are analysed and weighted alongside other factors, this may lead to claims that investors have been misled.
Perhaps the most obvious risk is the possibility of enforcement action by regulators. The United States’ Securities and Exchange Commission is taking greenwashing very seriously. Last year. its enforcement arm launched an ESG task force to investigate sustainability claims by investment managers and companies. As well as DWS (referred to above), Goldman Sachs’ asset management arm has apparently been under investigation for alleged greenwashing and in May, BNY Mellon became the first asset manager to settle with the agency for allegedly misleading investors about ESG claims.
Although enforcement action has been relatively slow in the UK to date, we expect this to pick up as it is in Europe and the US. Indeed, the FCA faces increasing public and political pressure to act. For example, the charity ClientEarth asked the FCA to penalise organisations such as JustEat for an alleged failure to comply with ESG disclosure obligations. With the plethora of new rules and guidance being issued by the FCA in this area, it seems only a matter of time before enforcement action is taken, so financial services firms should act now to address any potential issues.
Increased regulatory attention on ESG issues may cause consumers and shareholders to examine the credentials of their investment products with greater scrutiny. This in turn may lead to an increase in claims. The Financial Ombudsman Service may start to receive more complaints related to alleged greenwashing and investors may also bring litigation claims against firms for misrepresentation or misselling ESG (or other ESG-related or sustainable) financial products.
Shareholders in listed financial services firms may seek to bring claims under sections 90 and 90A of the Financial Services and Markets Act 2000. Section 90 provides for a person to be compensated if they can show that they have suffered loss as a result of any untrue or misleading statement in a firm’s listing particulars or prospectus. Financial services firms may also be liable for compensation under section 90A in respect of misleading information published in other sources such as annual reports and accounts.
To date, no claim under ESG-related causes of action has gone all the way to trial. However, section 90A was considered for the first time at a full trial in the Hewlett Packard ‘Autonomy’ fraud case. The judgment, which was handed down in June 2022, considered the application of section 90A in a broader context but may also be instructive to shareholders wishing to bring section 90A claims in relation to misleading statements or omissions in relation to ESG credentials. The decision in Autonomy and others v Lynch and another demonstrates that proving such claims is complex and shareholders wishing to bring claims in respect of inaccurate ESG disclosure would have a high evidential burden. The relevant statement must be objectively untrue or misleading to its intended readership which is particularly difficult to prove in an ESG context. Added to that, a claimant would need to show that the person discharging managerial responsibilities in the firm knew or was reckless as to whether the statement or omission was misleading. Further, in the case of section 90A, a claimant shareholder must show that they bought, sold or held their shares in reliance on the published misleading information. Though there is a rebuttable presumption that a claimant was influenced by a false or misleading statement that was likely and intended to influence their investment decision, the claimant must still show that their reliance on the misleading or untrue statement was reasonable.
All of these considerations could be problematic in the case of ESG class actions, likely having significant litigation costs consequences which could deter litigation funders.
So how concerned should firms be about the risk of ESG related litigation? The answer is that firms wanting a stake in the ESG investment fund market need to think proactively and pre-emptively about the risks of doing so. Even if ESG related claims are not yet flooding the courts, there is little doubt that the eyes of both regulators and investors are increasingly trained on the ESG-related claims of investment products.
The market is driving continued growth in ESG-related products and with that comes further regulation and guidance. The UK government intends to publish a Green Taxonomy to provide guidance on what economic activities qualify as “green” and regulators such as the FCA may respond by introducing ESG reporting requirements in the future. To stay ahead of developments, seek early advice and engage specialists who can carry out sustainability assessments, provide advice on regulatory law and develop appropriate marketing.
Once a fund is active, keep clear records to demonstrate how the fund is being managed in accordance with its ESG credentials. Think about the data that influences those decisions and how that data can be recorded. Investors, regulators and activists will also look at a firm’s broader commitment to ESG so firms need robust internal ESG policies in place. These should be supported by an appropriate level of ESG training and awareness at an employee and senior management level.
In the constantly evolving ESG funds market, financial services firms need to meet the demand whilst protecting themselves from the risk of greenwashing allegations and ESG-related disputes. To manage these risks, firms need to take stock of their ESG-related products and ensure they can withstand both regulator and increasingly sophisticated customer scrutiny.
If you require further information about anything covered in this briefing, please contact, Kya Fear, Henrietta Richards, Hoi-Yee Roper or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, Novemer 2022