In summary

“ESG” in fund management could be set to die on the altar of “fashion”, due to recent push back from some fund managers. However, as much as some of these fund managers may want this to happen, most of the public, investors and consumers do not.

We think that new trends in the public square will shift ESG in fund management from privately defined and managed to publicly defined and managed.

We, at Libryo, think this is a good thing.

In detail

“The lack of specific disclosure requirements tailored to ESG investing creates the risk that funds and advisers marketing such strategies may exaggerate their ESG practices or the extent to which their investment products or services take into account ESG factors. With respect to environmental and sustainability factors, this practice often is referred to as “greenwashing.”

- Securities and Exchange Commision, proposed rule,
Enhanced Disclosures by Certain Investment Advisers and
Investment Companies about Environmental,
Social, and Governance Investment Practices. 

In the news this week (31 May 2022): the biggest asset manager in Germany (DWS) was raided by the German financial regulator (BaFin), for ESG greenwashing (prospectus fraud). DWS CEO (Asoka Wöhrmann) announced that he was stepping down the following day, as a result.

The DWS former Global Head of Sustainability (Desiree Fixler), who had raised concerns internally, later turned whistle-blower, after claims of being ignored and then fired. Essentially, Fixler claimed that the DWS ESG Risk Management System was highly flawed leading to, at best, inaccurate labeling of investments as being “ESG”, and, at worst, a pure marketing exercise aimed to label high-performing funds as “ESG” whether or not they were behaving as the investors would expect from ESG. Following Fixler’s complaints in 2021, DWS changed its reporting criteria and language in its annual report from “€459bn in assets are ESG integrated” in 2020 to “€115bn in ESG assets” for 2021. The SEC also launched a probe into DWS for overstating its ESG credentials in August 2021.

Many see this as a case providing evidence of widespread greenwashing by funds and portfolio companies everywhere. ESG has been a rapidly growing trend in financial asset management (some would argue merely an evolution and reframing of SRI), with many investors wanting to be assured that their investments and savings are being used to  support companies who make a good financial return, while also behaving well as citizens of the world, in terms of ESG.

More recently, ESG  is becoming a highly charged topic amongst fund managers, where some are questioning the trustworthiness of ESG Reporting and the integrity of the claims of ESG Investment Funds, and  others are questioning the whole idea that businesses should care about or be responsible for ESG, and see the ESG trend as an instance of “Woke Capitalism”

Despite much progress, there are currently no globally adopted and applied standards in regard to what “ESG” means and how it is measured; no consistent or thorough regulation in regard to ESG criteria and reporting metrics; and no clear transparency requirements or regulations around truthfulness in reporting and marketing (although this is closer to reality now with recent developments, see more below).

ESG is now a huge investment class, with approximately $3trn invested in so-called “ESG” Funds.

Due to the lack of standards and regulations, companies have taken onboard a large part of the role of defining how it should be measured, managed, and reported on. As you would expect, there are some good and some bad actors, pockets of high competence, and others where the methods and results are weak.  Part of differentiating as a fund now is having a “proprietary ESG process” (like DWS has) and, for service providers, to also do something unique as their unique selling proposition. Index and Standards bodies create proprietary and optional indices and standards. A whole industry of ESG software, ESG Indices, ESG standards and ESG consulting has arisen, as well as many prior products and services rebranding or reframing what they do as “ESG”.

All of this makes the lack of global cross-comparison of ESG performance practically impossible. The only way to address all of this is to either (a) give up on the notion that companies can or ought to manage ESG; or (b) create and enforce regulation, including global standards that are legally required (like the accountancy practices regulated with reference to IFRS) that ensures every company measures, manages, and reports in the same ways.

The ongoing growth in the ESG trend shows that consumers (retail investors and those who have money managed by institutional investors) don’t want to give up on the gains of ESG, and won’t allow that to happen. Essentially the shoe has dropped and there is no way that companies and asset managers will be able to get back to a state where in popular culture it is accepted that “the only purpose of business is to make money for shareholders” (or some variation of that sentiment).

ESG will thus remain a competitive differentiation, and the pressure will continue to increase for financial market participants to tell the truth, clearly and to prove their claims with audited data. Legal jurisdictions will continue to take different approaches as to how they regulate, but regulations will tend to get more specific, more onerous, better enforced and in time, will become more globally aligned, consolidating around a few global standard approaches - such  as the ISSB - see the recent consolidation of the Value Reporting Foundation and Climate Disclosure Standards Board into the IFRS Foundation. There are other consolidations happening in the ESG standardisation space too, and it’s still not clear which global standards will ultimately emerge as the favoured one(s) with regulators.

ESG measurement, management, and reporting will shift from a voluntary, “choose your own adventure” exercise for funds and portfolio companies to an ESG Compliance function, against a ream of growing and often changing legally required government and regulator mandates, in concert with globally adopted standards that are legally binding (based on signatures at the point of formal adoption, with new specific legal obligations for signatories).

In “ESG”regulation, we see growing new regulatory and enforcement activity, for example: EU Taxonomy and SFDR Regs; Prop 64 in California; Proposed SEC Rules for enhanced ESG disclosures, and various recent investigations into allegations of greenwashing by the SEC.

Deeper Dive: Libryo Cofounder, Garth Watson published “How the black box of ESG disclosures and ratings is being blown open” on 24 May 2022, which is a great read if you’d like a deeper dive.

The new regulations are tending towards creating a thorough and detailed prescription of how ESG issues are defined, how performance should be measured, managed, assessed and reported on. When this work is properly done by funds and portfolio companies, these ESG frameworks, as defined in regulation, will enable all stakeholders to compare the ESG performance of funds and portfolio companies in a way that has not been possible with the choose-your-own-adventure current regime. 

In time, this should create an environment in which the good and competent actors thrive, the bad or incompetent actors are penalised or pushed to improve. 

Ultimately we should see a more just and sustainable world as a result - something we at Libryo exist to ensure.

In conclusion

ESG as it’s been done until now is dying. A new regime of ESG Compliance is taking over. 

This is not a popular message for some, especially those for whom ESG has basically been a pain in the butt, with the only consolation to them being that it can be a helpful marketing tool.

The new ESG Compliance regime will require sophisticated tools and processes in order to understand and manage:

• Context-based applicability of all possible regulation (see the ISO 37000 Hierarchy of Laws, Guidelines and Other Acts impacting Governance of Organizations as a scope of what I intend to mean here)
• Understanding the operation-specific requirements within the applicable regulations
• Keeping abreast of regulatory change and resultant requirements and compliance impacts
• Assessment of compliance performance, comparable across global operations
• Reporting on performance in a cross comparable way that has ESG integrity
• Continuous Improvement of ESG compliance performance.

If you agree, or would like to discuss more about how Libryo can help - please reach out!

Read more

• DWS is in Deep Doo-Doo Over Greenwashing – Here's Why - Morning Star
• German police raid DWS and Deutsche Bank over greenwashing allegations - Financial Times
• CEO of Deutsche Bank's asset manager steps down after 'greenwashing' raid - CNN Business
• Blowing the whistle on ESG - Behind the Money (podcast)
• DWS boss resigns amid greenwashing claims - World Business Report (podcast)