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Asset managers fear exaggerated claims over sustainability-focused investments could become a mis-selling scandal across the industry after regulators on both sides of the Atlantic sharpened their focus on environmental, social and governance investing at Germany’s DWS.
Investigations by regulators in Germany and US, triggered by allegations made by DWS’s former global head of sustainability, have put greenwashing — unjustified claims about environmental practices — centre stage for Europe’s investment industry.
Rival fund houses now fear they also could come under scrutiny over claims of sustainability, which is hard to measure and varies greatly from one fund to the next.
“The definition of what ESG or responsible investment truly is has been up for debate ever since it was created,” said Sébastien Thevoux-Chabuel, a portfolio manager at Comgest. “[What] has happened to DWS could happen to almost any investor.”
Desiree Fixler, who was sacked earlier this year from her role as global head of sustainability at DWS, has alleged the German asset manager made misleading statements in its 2020 annual report, where it claimed more than half of its $900bn in assets were invested using ESG criteria.
DWS last week defended how it represented its numbers, saying it was always clear that it differentiated between so-called “ESG integrated” assets, where sustainability issues were considered as part of the broader investment process for mainstream funds, and ESG assets, which are specialist products with a mandate to focus on sustainable investing.
Both BaFin, the German financial regulator, and US officials, have opened investigations in to the matter.
Asset managers have showcased their sustainability credentials in recent years on the back of huge demand for ESG investments. Total assets in sustainable funds hit $2.24tn at the end of June, up from less than $1tn at the end of the first quarter of 2020, according to Morningstar, the data provider, as investors sought out investments that do good for the climate and society as well as generating returns.
But Catherine Howarth, chief executive of ShareAction, the responsible investment charity, said asset managers’ credibility on ESG investing “needs to be tested to the nth degree”.
“I don’t think DWS is the worst out there by any means,” she said. “If DWS has this problem, then a lot of other asset managers have this problem. I don’t think they were an outlier or a total pariah there — lots of others [asset managers] were doing something similar.”
Claims over sustainability differ hugely among asset managers and their customers. Some asset managers avoid fossil fuel-related stocks entirely, for example, whereas others believe it is better to invest in oily stocks and use that as a way to pressure company boards — an approach that may surprise some of their customers. Some fund managers buy bonds that inflict a penalty on borrowers if they fail to hit green targets; others see that as a reward for failure.
Data providers that grade companies by sustainability metrics also generate different results. “Data quality is really bad,” said one industry executive familiar with DWS’s work in this space. “It’s like trying to invest with data from the 1980s.”
Several investment houses last year blamed poor ESG data after they came in for heavy criticism over the inclusion of Boohoo in many sustainable funds, despite accusations of poor working practices in factories that make its clothes.
A survey published last year by BlackRock of 425 investors, together representing $25tn in assets under management, found that poor quality or availability of ESG data and analytics represent the biggest obstacle to sustainable investing.
In addition, most big asset managers claim to integrate ESG into all of their investments. Again, however, this is poorly defined. At one asset manager, integration could mean portfolio managers have to consider a company’s ESG score before buying a stock, while at another they might be excluded from buying certain shares.
“Integration differs by asset manager. The greenwashing comes in if they are doing something different to what they say they do,” said one ESG specialist at a global asset management company.
“My biggest fear is waking up in the morning to find out we have been accused of greenwashing. It is the next mis-selling scandal,” he said, adding that the soaring popularity of sustainable investing meant “something like this was always going to happen”.
In July, the Financial Conduct Authority, the UK regulator, wrote to all asset managers to highlight concerns about applications to launch new funds with an ESG or sustainability focus, warning that these “often contain claims that do not bear scrutiny”.
Other regulators are also stepping up attention on ESG investing. New European rules, which came into force in March, are designed to stop greenwashing. The EU Sustainable Finance Disclosure Regulation imposed new ESG reporting requirements on asset managers and other financial market participants.
BaFin, Germany’s financial regulator, has also launched a consultation with the aim of tightening the requirements that asset management companies will be obliged to meet when setting up sustainable funds aimed at retail investors.
This all suggests that regulatory investigations into DWS are unlikely to be a one-off.
“It does seem as though there is a deal more positive talk about ESG and a little less delivery in practice by many fund managers,” said one specialist working in the investment industry.
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