Police raid a fund manager for… greenwashing!?

Sascha: [00:00:02] From Equity Mates media. This is the dive. I'm your host, Sascha Kelly. Last week, one of the more surprising police raids took place in Germany. 50 police officers raided DWS Group, a subsidiary of mega investment bank Deutsche Bank. The alleged crime. Greenwashing. For those unfamiliar with the term greenwashing is when a company markets their product as sustainable or environmentally friendly when it really just isn't so. It's classic marketing spin, but. 

Audio clip: [00:00:34] Again, it's a lot of sizzle, no steak. 

Sascha: [00:00:36] And in the investing world, greenwashing has become more and more of an issue over the past few years as more and more money flows into investment funds that are advertised as sustainable or ESG focussed. Still, a 50 police officer raid feels like a big overreaction. It's Friday, the 10th of June, and today I want to know how big an issue is greenwashing in the finance industry and what's being done about it. To help me get to the bottom of this today, I am joined by my colleague and the co-founder of Equity Mates, Alec Renehan. Alec, welcome to The Dive. 

Alec: [00:01:11] Thanks, Sascha. This is an exciting story. ESG Sustainable Investing easily the biggest theme in the Equity Mates community. So I'm excited to get into this one today. 

Sascha: [00:01:20] Let's start, though, with what happened. It feels like a lot. Is greenwashing even a crime? 

Alec: [00:01:27] No. But fraud or misleading the market. 

Sascha: [00:01:31] Is a fair point.

Alec: [00:01:34] DWS are alleged to have misstated the amount of money they have in ESG assets. 

Sascha: [00:01:39] Look, before we get any further, we've said the word ESG a lot, just in case you don't know what it is. Can you define ESG for me? 

Alec: [00:01:47] Yes. ESG stands for environmental social governance. And when someone says investing in ESG or ESG assets, what they mean is that they've used some criteria to assess the environmental or ethical merits of an investment. 

Sascha: [00:02:03] Okay. So let's get back to the story at hand. What happened? 

Alec: [00:02:07] So in 2020, data was reported to the market that over half of their $900 billion in assets under management were invested using environmental, social and governance criteria. The allegation is that they knowingly misled the market with that claim. The allegation is they lied basically. 

Sascha: [00:02:27] As was itself claiming that they are well. 

Audio clip: [00:02:30] Ahead of the competition to include. 

Sascha: [00:02:32] ESG criteria in their portfolio. 

Alec: [00:02:35] The reason these allegations came to light is that data was fired, that chief sustainability officer Desiree, who turned around and blew the whistle on the company. German and American authorities then started investigating. 

Sascha: [00:02:49] Well, then the big question is, did they lie? 

Alec: [00:02:52] So, look, we don't know at this stage. The companies denied wrongdoing, but the CEO has resigned just hours after the police raided the offices. And in their 2021 report, they announced 75% less ESG assets than in the 2020 controversial report. So whether they lied or not, it seems that at the very least, they've changed their methodology. 

Audio clip: [00:03:18] Prosecutors say they have enough evidence to support the allegations of greenwashing. DWC has repeatedly denied those claims. 

Sascha: [00:03:27] Okay, that does sound a little fishy, but that's all. 

Alec: [00:03:30] Well. 

Sascha: [00:03:31] So yeah. I won't pass any further judgement. But greenwashing isn't new. It has been around in consumer products for years, but it's starting to emerge more and more in the financial markets. So to help us get our heads around what greenwashing is exactly. Can you give me some famous examples and consumer products? 

Alec: [00:03:52] There have been a number of famous cases over the years when it comes to products and services that we buy. McDonald's in 2019 announced that would use paper straws.

Sascha: [00:04:02] The Golden Arches are saying goodbye to plastic straws in the UK and Ireland for now. 

Alec: [00:04:06] Only for it to come out that it couldn't even recycle those paper straws. 

Audio clip: [00:04:10] As it turns out, the much hated straws weren't even recyclable. According to an internal McD's memo obtained by the Sun, the paper versions needed to be binned and burned. 

Alec: [00:04:19] Volkswagen, probably the most famous example, admitted to cheating emissions tests. 

Audio clip: [00:04:23] People were duped into believing they were buying a green vehicle that was not green. 

Alec: [00:04:28] The owner of Kleenex, Kimberly-Clark, has been accused of greenwashing with their flushable wipes and were even taken to court a court case. They did win actually in Australia. 

Sascha: [00:04:39] Flushable wipes, which the ACCC claims are anything but. Okay, so plenty of examples of greenwashing in consumer products. But let's get back to the DWC story and financial services. To me, ALEC, it just feels like such a bizarre and unnecessary crime. Why would you allegedly need to lie? About the amount of ESG assets that you're investing in? 

Alec: [00:05:02] Well, I think it's because ESG is easily the biggest trend in the investing world. 

Audio clip: [00:05:07] We believe that sustainable investing is the strongest foundation for client portfolios going forward. 

Alec: [00:05:13] It starts with investors. They are the ones that are driving this trend for two reasons. First of all, investors, people like you and I. Big institutions, people that have money to be invested care about how that money is invested. They don't want their money supporting companies that they don't think ethical fossil fuel companies, porn companies, gunmakers, alcohol gambling. They're some of the common categories of companies that are often screened out when we talk about ESG. The second reason is that investors believe that ESG funds actually do better than the overall market. Last year, more than half of ESG linked funds outperformed the S&P 500 America's benchmark index of their 500 biggest companies. But whether or not ESG actually does outperform. The important thing is that investors believe it outperforms and that's driving the demand. 62% of Australians surveyed believe that ethical or responsible super funds perform better in the long term. And that number, 62%, was double the previous survey in 2017. So first of all, investors care about how their money is being invested. And secondly, they think it gets better returns. 

Sascha: [00:06:28] So it's clear that from what you've said, that investors want ESG options and fund managers are offering a service, you know, investment management. So it's natural to them think if they do make their funds more sustainable, then they're going to attract more money. 

Alec: [00:06:44] 100%. There are a wide spectrum of fund managers with different levels of commitment to this ESG cause. But you said it at the start. For a lot of them, it's marketing spin. It's a way to attract more money. 

Audio clip: [00:06:56] Well, to paraphrase the legendary investor Warren Buffett, Wall Street is somewhere where quality control is not prised, and they will generally try and sell you anything that customers will buy. 

Alec: [00:07:05] And so we're seeing a range of actions being taken by fund managers. Some are just slapping ESG or sustainable in the name or on the label, but some are doing a lot more. You know, they're setting climate targets. There are a number of asset managers that have actually signed a net zero pledge. So there's a range of actions being taken here. Globally, there's about $100 trillion under management in the finance industry today, 35 trillion of that is invested under ESG or sustainable criteria. Huge amount of money. And you can imagine the broad array of fund managers sitting under that. And it's expected to grow 35 trillion today. Bloomberg expect that to be 50 trillion by 2025. So, Sascha, expect even more confusing choice in the next couple of years. 

Sascha: [00:07:56] More confusing choice for me, I'm guessing from this scale of investment that DWS, while they might be the ones in the headlines, they're not alone in greenwashing alleged. 

Alec: [00:08:10] They're definitely not alone. But there haven't been a heap of regulatory actions. It's pretty new to say police raids or regulators cracking down. We saw earlier this year the US take their first regulatory action. The SSA fined the investment arm of Bank of New York Mellon Corp one and a half million dollars for misleading claims about funds that supposedly used ESG criteria in stock selection. This is very similar to the allegations about DWS in Germany. But these are really like the first cases, the test cases. But that's not to say there isn't more out there.

Audio clip: [00:08:48] We did a study on investment funds in Germany, invested in shares. We looked at more than 100 funds last year. And what we found is that their investments are not much different from those marketed as conventional funds.

Alec: [00:09:02] And Sascha, I think this quote from the Financial Times sums it up better than I could quote, if it was is guilty of unlawful greenwashing, then there are likely a lot of investment groups that should feel uneasy. The problem is that ESG as a whole and each of the E, s and G individually is an unholy mess of subjective assessments based on patchy, arbitrary data that allows anyone to say that they are ESG compliant. 

Sascha: [00:09:31] Unholy Mess of subjective assessments. I love that phrase. So greenwashing is an issue in the finance industry. And if we know about it, if 50 German police offices are raiding a fund manager, then I've got to assume, maybe falsely, that someone's doing something about it. So let's talk about those efforts after the break. Welcome back to The Dive. Today we're talking about greenwashing. I guess the question in front of my mind is, is anyone trying to stop greenwashing?

Alec: [00:10:13] Look, there are there are efforts underway. That is the good thing. We are seeing some movements in this space. How effective those efforts are not for us to judge, but the US is the main jurisdiction at the moment. The Securities and Exchange Commission, the regulator that regulates financial markets, has proposed two new rules. The first one is a disclosure and reporting framework, and the second is an update to their name rule. So first one, disclosure and reporting framework. It would basically, as the name suggests, require these ESG funds to disclose how they incorporate ESG factors into their investment decisions and then report on that ongoing. The second rule that's been proposed is an update to the name rules. So currently in the States, if you have a investment product, you know, a fund or anything that people can put their money in and it has a particular name, then 80% or more of the assets in the fund must be aligned with that name. So to give you a practical example, if I have an Australian share fund, then at least 80% of the money has to be invested in Australian shares. 

Sascha: [00:11:22] Only 80%. Not 100%. 

Alec: [00:11:24] Not 100%. That rule didn't traditionally apply to sustainable funds or ESG funds, but the proposed update is that it soon will. 

Sascha: [00:11:34] Good. That's all I can say. 

Alec: [00:11:37] So the rules were proposed in late May. There's a 60 day comment period, so we expect to see them implemented later this year. 

Sascha: [00:11:45] Okay. So that's the U.S.. Are there any other jurisdictions that are trying to put any regulations in place? [00:11:51][5.8]

Alec: [00:11:52] Europe is really leading the charge here again. And European 

Audio clip: [00:11:55] Regulators are also trying to provide a framework which all fund managers must follow to prove they have an ethical path to any decision they take if they're promoting themselves as ESG. 

Alec: [00:12:04] Funds. The UK government are trying to produce a green label system for investment products. These are good. These are steps in the right direction. Some have criticised the EU, the UK and the US requirements as perhaps not doing enough or being a little too loose. 

Audio clip: [00:12:20] I think if this goes through as proposed by the European Commission, we then have a uniform standard which will let credibility and that would be a huge problem for the market because it's in need of like a clear and strict standard for what's sustainable. And then we can we can tackle greenwashing better. 

Sascha: [00:12:40] What about Australia? 

Alec: [00:12:41] Look, Australia has no overarching source of ESG regulation, and ESG reporting remains voluntary. 

Sascha: [00:12:49] I mean, Alec, I knew it was a big topic and I knew it was a very grey area to define. But I think clearly falsely, I'd assumed that people are smarter and more invested than I were making rules about this. And what you've just said is that that's kind of not the case. 

Alec: [00:13:07] It's kind of not the case. But I guess before we criticise regulators too much, we should say this is an incredibly hard part of the market to regulate. I'm going to put you in the shoes of a regulator, Sascha. You are the new commissioner of Ask. How do you even start to define what is sustainable?

Sascha: [00:13:26] Yeah, that's such a good question because I think every time I come up with something that I think is sustainable, I'll find a hole in that argument and I'll suddenly go, Oh, you know, it might be good for the environment, but their management seems to be terrible. Like, you know, things that are important to me, like gender equality or, you know, board representation, you know, you just can't seem to get everything right all of the time. 

Alec: [00:13:50] Yeah, 100%. Tesla is always the classic example here because it's like Tesla electric cars probably doing more than any company to confront climate change, but it's probably also doing more than any company to undermine worker protection.

Audio clip: [00:14:04] And Elon Musk has just joined the debate. Musk had previously called ESG a scam that had been weaponised by phoney social justice warriors after Tesla was kicked off the S&P ESG Index. 

Alec: [00:14:16] Not great governance and calling employees back during the pandemic.

Sascha: [00:14:20] It's already hard enough for me to define what sustainable, let alone to then come up with a global definition of what that would be. Because just depending on where in the world you live, you're just going to have a very different understanding of what's important to you. 

Alec: [00:14:33] And that's the challenge of balancing the E and the S and the G. But even within those letters of the acronym, those difficulties, like let's just take a let's just say I want to invest in something that's climate focussed uranium and nuclear power becomes a classic example of is it in or is it out? Because on one hand it's zero carbon, it doesn't emit, but on the other hand it's not renewable mining, it isn't great. We don't have great uses. Left. Like spent uranium. So there's not a good, like, end of life process. So Sascha commissioner of basic in or out of our ESG funds, I. 

Sascha: [00:15:10] Think I want to find another job. That would be my solution. Someone out there is going to be better qualified for this than me. 

Alec: [00:15:18] I think because of all this grey area, that's why a lot of the regulation is ending up. We want really good disclosure and good reporting. So you as a fund manager can make your own determinations on all of that. Is Tesla in or out? Is uranium in or out? And then as long as you're very transparent and clear about that and then you report on how the stocks or the bonds or whatever you're buying fits in that framework. That disclosure is where we're at currently, because I don't know how you would go about defining what is ESG and what is, and then it constantly changes as well with new technology and more knowledge. 

Sascha: [00:15:55] Yeah, absolutely. So we're letting the regulators off the hook a little bit. You know, we're giving them a bit of a pass, but we recognise it's not black and white. We still have individual responsibility. So while we're waiting for this regulation to be more concrete, to be more defined, what do you think we should be doing as individual investors? 

Alec: [00:16:15] I don't think the regulators will ever be able to do the work for us. Unfortunately, we as individual investors need to look under the hood, I guess, and say where the money is being invested and how it's being invested and if that aligns with our values. So the first step is actually to figure out what matters to you. Are you only worried about climate change? Do you also care about worker protections, fair pay, gender equality on boards? There is such a long list of things that could fall under this, so you have to decide what matters to you. And then it's about finding individual companies or fund managers that align with your values. All we can do as individual investors is keep asking questions of fund managers, of companies, keep putting the pressure on and keep voting with our dollars in the same way that ethical consumerism has been a real trend of the last probably two decades. We're starting to see ethical investing do the same thing. We're starting to see it push fund managers and product issuers to do more and to do better. And everyone's can vote with their wallets, vote with their brokerage. And all we can do is keep keep putting that pressure on. 

Sascha: [00:17:23] So I think we can wrap it up there for today. But this is definitely going to be a topic that I'm sure we'll return to. So thank you so much for joining us for today's edition of The Dive. If there's a story that you want us to talk about, if there's a greenwashing topic that has piqued your interest that you're curious about, then let us know. The dive at Equity Mates dot com is our email address or follow us on social media and of course all those details in the show notes below. Remember, please give us a rating and a review in whatever podcast app you use. It does make all the difference we would love to get in front of more is so every little bit that you can do in that way, it really does help us and make sure you subscribe to that. Every time there's a new episode, it's right there in your feed. So until next week. Alec, thanks so much for joining me today. 

Alec: [00:18:10] Thanks, Sascha.