Partner and Head of the Investment Fraud and Mis-Selling Team Mark Kenkre, Associate Matt Sumpton and Paralegal Ufedo Omale examine the impact of greenwashing in ESG funds on investors, and the potential to seek justice through collective redress, in Law360.
Mark, Matt and Ufedo’s article was published in Law360, 29 April 2022, and can be found here.
Consumer expectations are changing, with increasing demands on companies, even governments, to prioritise and publicise their approach to “Environmental, Social and Governance” (ESG) issues. ESG issues cover things such as environmental management practices, consumer protection and corporate obligations. When a company promotes its ESG practices, it creates an impression to consumers that it conducts its business in an ethical and sustainable manner; that it carries out “good corporate citizenship”. This is no longer just a ‘nice to have’ aspect in business. This trend has also led to the rise of ‘ESG funds’: investment funds which carry the labels ‘ESG’ or ‘Sustainable’ and other such synonyms. However, there is a growing concern amongst investors and the press that many of these funds are not always as environmentally friendly as their names would suggest.
Policy changes and investment trends today reward businesses for positively engaging in ESG. There is a clear attraction to companies that meet this standard with records showing 83% of millennial consumers want brands they buy from to align with their values. This statistic extends specifically to investment, with the addition of non-financial factors steering people in their decision-making process. There is a growing demand from investors for funds which offer sustainable investment. This is evidenced by the over 3 trillion US dollars held by European sustainable funds by the close of 2021. This is driven by a desire to protect their assets against the potentially damaging consequences of climate change, as well as a push from investors who want their portfolio to align with their own personal values. These types of investors will rely on descriptions such as “sustainable” or “ethical” or “environmentally friendly” when deciding where to put their money. If those descriptions turn out to be false, those investors will have suffered an injustice.
The Financial Times reported recently on the example of an investor who moved their investment to the online wealth platform “Nutmeg”. The fund was labelled under an “ESG Investment Option” but when the investor investigated the fund’s underlying holdings, they discovered that they were merely bank stocks with ESG policies – not very different from any other fund. That investor was disappointed but there was no suggestion that she was misled. However, the article raises questions for legal professionals about whether different fact patterns might give rise to litigation.
A typical fact pattern which might give rise to a claim for ‘greenwashing’ mis-selling might look as follows. A company/fund either: (1) promotes environmentally friendly programs to intentionally deflect attention from an organization’s environmentally harmful or unethical activities; or (2) Negligently or intentionally presents an environmentally responsible public image which is unfounded. If one examines the rules which fall under the umbrella term of ‘mis-selling’ there would be a number which a private investor could rely on to bring a claim for mis-selling. For example:
- A claim under the Financial Conduct Authority’s (FCA) Conduct of Business (COB) Rules.
- If advice has been given which is misleading, a claim in contract or tort;
- A claim for misrepresentation under the Misrepresentation Act 1967;
breach of a duty not to misstate the position negligently; and/or
- fraudulent misrepresentation
Each of the causes of action above has its own ‘building blocks’, but a key element of each of them would be to show that representations as to the ‘ESG’ or ‘environmentally friendly’ qualities of the funds were false. What counts as “false” in the context of an ESG representation has the potential to be the subject of litigation. Some hypotheticals are outrageous, but unlikely: a fund which claims to be “ethical” but which invests in weapons, for example, would be ripe for litigating, but one would hope no fund would be so brazen or reckless (and yet that premise has already been tested in an article published in light of the crisis in Ukraine). Consider, however, a fund which claims to be “sustainable”, but which invests in aviation? Or claims to be “environmentally friendly” but which invests in construction in greenbelt areas? These latter two are much more plausible but would have the potential to be argued fiercely by both sides as to “falsity”.
These are not just hypotheticals. Recent analysis has shown that only a small percentage of supposedly “green” funds in fact make any more than 10% of their revenue from green/sustainable sources. This leads one to ask what the minimum criteria needed to brand such funds as green might be? Where there is a very large range of companies within the portfolio, what is the threshold/minimum requirement before such labelling constitutes greenwashing? If this threshold is low, a green investment fund would only need to have a fraction of their portfolio actively (or partially) pushing forward on the sustainability front.
This also raises the question of “loss” in the context of a ‘greenwashing’ mis-selling claim. The authors of this article have identified three possible ways in which loss might theoretically be established (and recognise the potential for other arguments to be run). The first is the most simple, the value of the fund goes down, this causes the investor to look into the fund’s holdings to discover they were misled. The second, less straightforward, but consider a scenario in which the value of the fund was more expensive to buy than another fund not labelled “sustainable” or “ESG”; the investor has paid a ‘premium’ for a label which is not backed up in substance. Thirdly, the investor claims to have suffered loss based on the damage, or risk of damage, which the investment caused to the environment. The third option does not align with traditional definitions of loss under English law, but there are similar lines of argument being run in other common law jurisdictions (see, for example, Australian case McVeigh v Retail Employees Superannuation Trust (filed 2018) about whether an Australian pension fund violated the law by failing to disclose information on climate business risks and its strategies to address these risks. The concept of “loss”, along with “falsity” are likely to generate argument if there are investors that feel they have suffered injustice as a result of funds guilty of “greenwashing”.
As scrutiny increases, the potential to discover that funds have misled investors over their ESG credentials increases too. If evidence of greenwashing is uncovered, institutional investors may have the resources to swiftly seek remedy through the Courts, but retail investors may need to group together in order to hold misleading funds to account. The funds themselves may begin to review their portfolios and practices, prompted by the FCA’s launch of the ESG Sourcebook at the beginning of this year, which solidifies previously existing rules and guidance for firms to navigate environmental social and governance issues. As this new investor landscape develops, the law may have to adapt to meet the challenges these new “green” funds have generated.