Is Your Socially Responsible Investment Fund Green or Greedy? How a Standard Esg Disclosure Framework Can Inform Investors and Prevent Greenwashing

• Jurisdiction: United States,Federal
• Citation: Vol. 57 No. 1
• Publication year: 2022

Is Your Socially Responsible Investment Fund Green or Greedy? How a Standard ESG Disclosure Framework Can Inform Investors and Prevent Greenwashing

Cara Beth Musciano

Is Your Socially Responsible Investment Fund Green or Greedy? How a Standard ESG Disclosure Framework Can Inform Investors and Prevent Greenwashing

Cover Page Footnote

J.D. Candidate, 2023, University of Georgia School of Law; B.S., 2012, College of Charleston. Thank you to Professors Bruner and Mangan for your helpful comments and to my family for your love and support.

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IS YOUR SOCIALLY RESPONSIBLE INVESTMENT FUND GREEN OR GREEDY? HOW A STANDARD ESG DISCLOSURE FRAMEWORK CAN INFORM INVESTORS AND PREVENT GREENWASHING

Cara Beth Musciano^*

As environmental, social, and governance (ESG) investing exponentially increases, so does the level of inconsistent ESG disclosures, adding to investor confusion. Without any mandates for standardization, companies will continue disclosing their sustainability efforts without concrete facts behind their subjective claims in hopes that they will appear "greener" to investors. This practice—known as greenwashing—could become prevalent, resulting in capital intended for sustainable investments flowing toward harmful businesses investors sought to avoid. Regulators should develop a mandatory ESG disclosure framework to create accurate, reliable data and to prevent capital from being misallocated against investors' genuine sustainable efforts. Some existing rules could hold those misstating their ESG efforts responsible, but the potential for asset managers of ESG funds to greenwash their financial disclosures needs to be addressed by mandating a standard ESG disclosure framework.

An ESG fund disclosure framework, like those developing in other countries, is necessary for asset managers when drafting disclosures and labeling ESG products as part of an overarching guide with similar frameworks for all market participants pursuing sustainability. By creating consistent ESG data among portfolio companies, asset managers, and third-party raters, investors can properly inform themselves, better evaluate greenwashing claims, and ultimately mitigate greenwashing.

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TABLE OF CONTENTS

I. INTRODUCTION...................................................................429

II. INVESTMENT GREENWASHING..........................................436

A. WHAT IS GREENWASHING?.......................................438

1. Defining Greenwashing...................................438
2. History of Greenwashing Claims.....................439

B. ESG INVESTING........................................................444
C. ESG FUNDS' INTERNAL POLICIES, EXTERNAL RATINGS, AND PERFORMANCE ....................................................448

III. ESG DISCLOSURES IN THE UNITED STATES....................451

IV. COMPARATIVE ANALYSIS OF ESG DISCLOSURE FRAMEWORKS...................................................................457

V. REMEDYING ESG FUND GREENWASHING..........................463

VI. CONCLUSION...................................................................468

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I. INTRODUCTION

Investors are increasingly seeking to invest in a socially responsible way by integrating environmental, social, and governance (ESG)¹ factors into their investing decisions.² Investment firms are responding to this rapidly growing trend by introducing socially responsible investment (SRI) products to match the rising demand.³ The global value of firms leveraging ESG data almost doubled between 2016 and 2020 from $22.9 trillion assets under management (AUM)⁴ to over $40 trillion.⁵ ESG investing spans asset classes and generally relies on various ESG factors incorporated into investment processes.⁶ But these supposed

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socially responsible investments may not be as green as their creators indicate.⁷

Although the Securities and Exchange Commission (SEC)⁸ recently began rulemaking and soliciting comments on potential ESG disclosure mandates,⁹ its past guidance from 2010 was not interpreted by market players to require industry-wide ESG disclosures, and no mandate exists in the United States yet.¹⁰ Since the SEC's past guidance, the United States Chamber of Commerce reported that fifty-nine percent of the companies surveyed are now voluntarily disclosing more ESG information.¹¹ The Sustainability

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Accounting Standards Board (SASB) reported that in the United States, eighty-eight percent of the 356 large-cap firms¹² that filed with the SEC in 2017 voluntarily disclosed some internal data regarding their ESG initiatives and that fewer firms used boilerplate disclosures in 2017 than in 2016.¹³ Further, nearly two-thirds of companies are engaging with their investors about climate risk, and almost half increased the detail in their climate reporting due to investor input.¹⁴ Yet the lack of any ESG disclosure standardization creates an information gap as more companies disclose ESG risks using data each company individually handpicks.¹⁵ This unregulated space is exhibiting increasingly inconsistent data, leaving room for companies to mislead investors by misstating their sustainability initiatives.¹⁶ The practice of misrepresenting sustainability efforts—known as greenwashing—is a growing concern for financial market participants who must rely on companies' subjective ESG disclosures to inform their

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investing decisions.¹⁷ This inconsistency is intensified by two dynamics. First, asset managers themselves lack any standardized ESG disclosure framework to reference when issuing their own financial disclosures.¹⁸ Second, numerous third parties rate ESG funds without standardized ESG terminology, leaving investors to rely on multiple raters with vague and often conflicting ratings that only add to the already vast ESG lexicon.¹⁹

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In April 2021, the SEC alerted asset managers about the risk of investor confusion from rapidly growing demand for ESG investing, the increasing number of ESG investment products and services, and inconsistent ESG definitions.²⁰ The effect is extreme in some cases: A shareholder advocacy group adviser called one investment firm "hypocritical" for promoting its SRI products while still investing in fossil fuel companies accused of suppressing climate research.²¹ As ESG investing and its inconsistent terminology continue to grow, more asset managers are attracting retail investors²² by touting their investments as sustainable while lacking objective qualifications for their claims.²³

Various efforts by both governmental and private entities have sought to address greenwashing. The SEC initiated rulemaking for

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potential mandatory ESG disclosures.²⁴ Larry Fink, CEO of BlackRock, the world's largest asset manager with over $10 trillion in AUM,²⁵ announced that BlackRock will incorporate the European Union's Climate Transition Benchmark into its ESG investing strategy.²⁶ Some scholars are generating theories to reconcile the lack of regulation with what companies must report under existing mandates.²⁷ Others discuss how various ESG asset managers, such as pension fund trustees and ESG mutual fund managers, could be

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liable for greenwashing under current laws and regulations.²⁸ Regardless of how greenwashing is confronted, organizations touting their sustainability need guidance from a standard ESG framework to mitigate the widespread inconsistency.

This Note argues that the appropriate regulators²⁹ should develop a standard ESG disclosure framework so that ESG asset managers can create market wide consistency for ESG funds' labels and prospectus disclosures. This would ultimately inform investors of material ESG risks and deter greenwashing. Part II defines greenwashing, discusses the history of greenwashing claims, and notes readily available legal actions as potential remedial avenues. Next, it discusses the rapid growth of ESG investing and the current system of various ESG metrics. Part III describes the current laws applicable to asset managers who offer ESG funds and ESG disclosure regulations. Part IV then provides a brief comparative analysis to consider foreign ESG disclosure mandates and frameworks. Finally, Part V argues how asset managers can use a standard ESG disclosure framework to better inform investors and ultimately mitigate greenwashing.

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II. INVESTMENT GREENWASHING

The environmental and financial sectors may not seem similar at first,³⁰ but their underlying, consumer-driven initiatives share a focus on sustainability.³¹ For the environmental sector, efforts supporting the environmental movement are commonplace, if not pervasive. Green initiatives are now almost a requirement for major market leaders: Google states that it has been carbon neutral since 2007 and aims to be carbon free by 2030;³² Amazon touts its "Climate Pledge Friendly" drive to support its goal to reach "net zero carbon by 2040;"³³ Nike's "Move to Zero" campaign promotes its drive for "zero carbon and zero waste" to "help protect the future of sport."³⁴ At first glance, these sustainability-driven initiatives may seem like little more than the latest "marketing ploy," but green consumers have long been motivated to consume responsibly and preserve the environment by factoring the planet into their

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purchasing decisions.³⁵ Consumer concerns behind the modern environmental movement began in the 1960s.³⁶ This movement set the stage for advertisers and marketers to target eco-conscious consumers, leading to increased regulation³⁷ and major legislation, such as the Clean Air Act and the Clean Water Act.³⁸

Today, the sustainability movement has reached nearly every type of green consumer, including those in the financial sector.³⁹ For example, by June 2021, over 4,000 asset managers around the globe had committed to actively incorporating ESG factors into their investment processes by becoming signatories of the Principles for Responsible Investment (PRI).⁴⁰...