Can the European Union stamp out greenwashing?
As of Wednesday, fund managers who market environmental, social, and governance (ESG) financial products will face regulations that force them to show exactly how they meet those standards.
The Sustainable Finance Disclosure Regulation, or SFDR, is part of the bloc’s Green Deal efforts to push genuine sustainable investing by forcing ESG products to disclose how their sustainably branded products will actually address climate change, among other requirements.
The rules require funds to classify their products into three different categories: products that support ESG goals in a binding way; products that invest purely in sustainable or other ESG initiatives; and finally, products that fall under neither category.
The rules will not be enforced by Brussels but will instead fall under national finance regulators. Greenwashing involves saying a product is environmentally friendly or sustainable on the basis of misleading or exaggerated claims.
The rules come amid a huge boom in ESG investing worldwide. According to Morningstar, assets in European sustainable funds rose by 55% in 2020 compared to the previous year, hitting €1.1 trillion by December. In the U.S., flows into such funds were almost double the pace in 2019.
There was also a surge in new offerings: 505 new “sustainability”-focused funds were launched in Europe last year, and 253 existing ones were rebranded to emphasize their environmental focus, Morningstar said.
The demand wasn’t just a European phenomenon. The number of new, ESG-branded ETFs and open-ended funds in the U.S. rose by a third in 2020 compared to the previous year. Morningstar said sustainable funds, in particular, “comfortably outperformed” their peers in 2020, especially equity funds, in both Europe and the U.S.
In this, they have benefited from an under-reliance on conventional energy stocks, and an overreliance on tech stocks, Morningstar noted, a pattern that rewarded investors in 2020. (Whether that will be the case in 2021 is another matter.)
But the strong returns and strong demand for ESG funds, particularly sustainable funds, have only exacerbated what even industry champions say is a perilous lack of transparent, easily understandable data on how exactly those funds meet often vague and inconsistent standards that makes responsible ESG investing challenging even for the experts.
A range of experts told Fortune that finding companies that ticked every E, S, and G box remained difficult, and indexes or funds that committed to one area often compromised on others.
A good example is Tesla, which is often found in ESG funds because of its emphasis on electric vehicles—even as governance issues and concerns about the treatment of its employees—or the G and S in ESG—have been well documented.
