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Greenwashing: Looking beyond the headlines

Synopsis: Greenwashing is equivalent to making an unsubstantiated claim, intended to deceive regulators, stakeholders, investors and consumers into believing that a company is more environment-friendly than it truly is. Some of the recent news indicates just how much of a controversial topic “greenwashing” is. French oil giant Total’s clashes with Greenpeace over Total’s claims on climate track record and initiatives is a case in point. Another instance is the former chief investment officer for sustainable investing at BlackRock Inc. claiming that sustainable investing boils down to little more than marketing hype and PR spin from the investment community. We agree that the Greenwashing issue directly relates with misrepresentation on companies’ performance or track record on environment related matters but it would be myopic to look at this as a problem which does not concern Governance. Any deliberate attempt on a company’s part to report incorrect or misleading data reflects poorly on the intent because transparency and maintaining data disclosure standards are much broader issues. Any company which is making an attempt to report data which they know is neither complete nor correct, should be held guilty on governance too. Although it may seem that everybody’s got their hands dirty but the situation is not as bleak as it sounds. Many of the companies are voluntarily adopting a proactive approach on environmental matters and they are reporting more than what is needed as per the prevalent requirements. This is a positive development in the right direction. The unethical practices of a few companies can’t undermine the overall progress being made on environmental issues. That being said, we also need to take a balanced view of what the holistic picture is for some of the sectors which are the favourite ‘whipping targets’ for NGOs and media alike. The important factor which needs to be considered here is that some of the businesses are at a natural disadvantage when it comes to their environmental track record. Businesses such as Oil Exploration and Production (E&P) companies, Oil Refineries, Conventional fuel-based Power Utilities, Mining companies and Auto companies are a few examples worth mentioning. While Greenwashing is a genuine problem for investors that could lead to wrong assessments on how they would factor in the environmental track record of a company in their investment decisions, the solution does not lie in ignoring the company’s initiatives. In that case, what could be the solution and the way forward? The following three points could shed some light:
a) We need to go beyond the official reported version
b) No two ESG scores are same despite the same headline figure because we need to look at the components more closely, and
c) An ESG score without context and background is meaningless.

Greenwashing: What it means and why is it in the News?

Greenwashing is the process of conveying a false or misleading impression or misrepresentation of facts or providing incorrect information about the steps an organization is taking to become more environment friendly or how a company’s products are more environmentally supportive. In other words, Greenwashing is often equivalent to making an unverified or unsubstantiated claim intended to deceive regulators, stakeholders, investors and consumers into believing that a company and its products are more environment-friendly than they really are. This could take different shape and forms such as misreporting on Sustainability and Environmental aspects of ESG (Environmental, Social and Governance) and making misleading claims to wrongly suggest an environmental benefit.

Because of the Coronavirus pandemic, the Sustainability discussions and how an organization’s operations impact the environment have become more mainstream. Naturally, the organizations are under pressure now to become proactive on their practices which would support the environment and help mitigate some of the challenges related to issues like Climate Change, Greenhouse Gas Emissions, Usage of Energy for per unit output and plans to replace use of Fossil Fuels with Renewable sources of power. As is the case in most of these situations, there are two main problems in making an assessment on how an organization is performing and they are, a) Is there a case of wilful misrepresentation?, b) Is there a problem in how different stakeholders view the same thing?

As Sustainability topics become more commonly discussed topics and as ESG gains prominence for investors, the scrutiny will also increase on how the companies are performing on these parameters. But more important will be their reporting. Following are some of the recent news which highlights the controversy that this topic generates:

  • The French oil giant Total clashes with Greenpeace over ‘inaccurate’ greenwashing claims as the company dismisses reports raising doubts about its emission cuts. Total and NGOs Greenpeace and Reclaim Finance are engaged in a dispute over Total’s claims on climate track record and initiatives.
  • Tariq Fancy, the former chief investment officer for sustainable investing at BlackRock Inc., the world’s biggest asset manager raised serious concerns on Greenwashing. He criticised the industry’s duplicity and wrote that sustainable investing boils down to little more than marketing hype and PR spin from investment community.
  • The Tech companies have been a big beneficiary of increased flow of funds into ESG or Sustainability themes and they are often considered better than peers from other sectors on their environmental track record. This however is not always the correct picture and there are chinks in their armour on this parameter. There are several media reports talking about the dubious practices that the Tech companies adopt in their reporting and their claims.
  • It’s not just the Technology sector that makes dubious claims. There are examples across industries. How many fashion brands claim themselves to be sustainable but are merely greenwashing? These brands, while damaging the environment with their conduct, also mislead consumers about their sustainability practices.

Is this a problem limited to Environmental Issues alone?

It is not easy to pick which of the factors matter more among Environmental, Social and Governance, but the problem is more complex than what the coverage on Greenwashing suggests. While Greenwashing is a serious issue and needs to be investigated on a case-by-case basis, there are certain important points which need to be considered here;

  • Often, the environmental issues grab a disproportionate share of media attention. There could be several reasons for this: a) the number of Non-Government-Organizations (NGOs) which focus on environmental issues is far higher than organizations focusing on Governance issues or Social issues which are impacted by the behaviour of companies, b) media often picks up stories which relates to environment and unless there is some serious misconduct involved, the social and governance issues are regarded as comparatively bland, c) the regulation is more progressive in case of environmental issues and it is yet to pick up steam in case of Social and Governance related issues.
  • The problem is not limited to environmental issues alone. As we have highted in the case of countries such as South Korea and China and for companies like Saudi Aramco, Alibaba and Top Glove, the Social and Governance issues are no less intriguing. There are challenges like whether the companies are trying to divert attention from Governance issues by focusing more on Environmental and Social issues (as the case with South Korea is) and if the investors are not paying adequate attention to progress on the Environmental issues because they are more focused on other parts (China). Similarly, there is evidence that Social issues get more coverage in company documents (Alibaba and Saudi Aramco) and how some of the companies will be caught napping on critical issues like employee health and Safety (Top Glove).
  • The Greenwashing issue directly relates to misrepresentation on companies’ performance or track record on environment related matters. But it would be myopic to look at this as a problem which does not concern Social or Governance parts. Let us look at the Governance angle first. Any deliberate attempt on a company’s part to report incorrect or misleading data reflects poorly on the intent. The transparency and maintaining data disclosure standards are much broader issues. Any company which is making an attempt to report data which they know is neither complete nor correct, should be held guilty on governance too. Similarly, if the environmental issues are not being dealt with the way they ought to be and if the company is circumventing regulations, that is a bad thing for society and community as well.

Volkswagen Emission Scandal: More of a Governance Issue than Environmental problem

Volkswagen Group, with its headquarters in Germany, is one of the world’s leading automobile manufacturers and the largest carmaker in Europe. The number of vehicles sold by the Group was 10.97 million in 2019 (global car market share of 12.9 percent). The Group comprises twelve brands from seven European countries: Volkswagen Passenger Cars, Audi, SEAT, ŠKODA, Bentley, Bugatti, Lamborghini, Porsche, Ducati, Volkswagen Commercial Vehicles, Scania and MAN. About six years ago, things changed drastically for the Group and as a result, it suffered a severe customer and media backlash.

The issue was related to compliance with pollution norms and the standards the auto companies had to follow. There were pollution norms which the company had to meet but the vehicles under its umbrella didn’t match up to those standards. Instead of trying to better their product, the company resorted to unscrupulous activities. The senior management conspired with company engineers to produce results which under testing conditions showed much lower pollution levels than the actual pollution generated by the same vehicles when on the road. Needless to say, when all of this came out in the open, the company had to face serious repercussions. But the biggest surprise in this entire episode was not that the pollution manipulation had happened, but the fact, which was much more difficult to believe, that the senior management was involved and had managed to keep it hidden for so long.

The Volkswagen emissions scandal began in September 2015, when United States Environmental Protection Agency (EPA) issued a notice of violation of the Clean Air Act to Volkswagen Group. The agency found that Volkswagen had intentionally programmed turbocharged direct injection (TDI) diesel engines to activate their emissions controls only during laboratory emissions testing which caused the vehicles’ pollution output to meet US standards during regulatory testing, but emit up to 40 times more pollution when out on the street.

Volkswagen deployed this software in about 11 million cars worldwide, including 500,000 in the United States, during 2009-2015. EPA found that many Volkswagen cars being sold in America had a “defeat device” – or software – in diesel engines that could detect when they were being tested, changing the performance accordingly to improve results and report much better performance under test conditions, sufficient enough to meet these pollution norms. The company admitted cheating emissions tests in the USA.

The ‘defeat device’ or the software was highly sophisticated. It could sense test scenarios by monitoring speed, engine operation, air pressure and even the position of the steering wheel. When the cars were operating under controlled laboratory conditions – which typically involve putting them on a stationary test rig – the device appears to have put the vehicle into a sort of safety mode in which the engine ran below normal power and performance. Once on the road, the engines switched out of this test mode. The result? The engines emitted nitrogen oxide pollutants up to 40 times above what is allowed in the US.

The group’s chief executive at the time, Martin Winterkorn, resigned as a direct result of the scandal. The company also launched an internal inquiry. It also had to recall millions of cars worldwide and the company posted its first quarterly loss for 15 years of €2.5bn in October 2015. Volkswagen has already paid out more than €30bn (£26.7bn) around the world in fines, compensation and legal costs. Still, there are many people who believe that Volkswagen was allowed to get off lightly for a crime which was very serious and for which the penalties and punishments should have been much harsher. But the fact remains that the issue is much larger and goes beyond a particular company or a specific sector.

But the situation is not as bad as it seems

Because of an increased usage of ESG as an investment filter by asset managers, there is an increased awareness of these issues among the companies. Many of the companies are voluntarily adopting a proactive approach on environmental matters. They are reporting more than what is needed as per the prevalent regulation and they are also coming forward to announce very aggressive targets on how they plan to support the environment and control climate change impact. This is a positive development in the right direction. And even if there are a few companies which are indulging in unethical practices, that does not undermine the overall progress being made on environmental issues. How to increase and expand the net impact of proactive and positive steps being taken by the companies so that it keeps going in the right direction should be the focus area for the asset managers and media.

ESG is an evolving area and the already frantic pace of change has reached an altogether different proportion as a result of the Coronavirus pandemic. It is thus natural to expect that the companies will be under pressure to report progress on what they are doing to support the environment. This could lead to some companies manipulating their data to come across as environment-friendly. But that doesn’t mean that every company is following suit because there are also several grey areas to account for such as,

a) If the company has to consider emissions as a result of their direct operations or they have to consider all their subsidiaries and indirect emissions too. In this case the reporting of direct emissions is not technically incorrect though it may be seen as incomplete, and,

b) The more sensational and outrageous claims might get more media coverage but that does not mean that the companies can be pronounced guilty based on media trial. That can only be confirmed after proper and thorough investigation.

We also need to take a balanced view of what the holistic picture is for some of the sectors which are favourite ‘whipping targets’ for NGOs and media alike. The important factor which needs to be considered here is that some of the businesses are at a natural disadvantage when it comes to their environmental track record. Businesses such as Oil Exploration and Production (E&P) companies, Oil Refiners, Conventional fuel-based Power Utilities, Mining companies and Auto companies are a few examples. They belong to the industry where polluting the environment is inevitable and as such their business model is based on an inherent disadvantage in this regard. They may not all be irresponsible and may not be deliberately misleading the data which they present on environmental parameters. But it is also true that they won’t be able to transform their business structure overnight.

How EMAlpha’s proprietary algorithms help?

While Greenwashing is a genuine problem for investors which could lead to wrong assessments on how they would factor in the environmental track record of a company in their investment decisions, the solution does not lie in ignoring the company’s initiatives. First of all, not all the companies are unethical and there could also be cases of genuine omissions and errors without any dishonest intention at the core. Secondly, the companies need to be incentivised for their efforts in addressing the environmental issues they are directly or indirectly responsible for. If the investors stop rewarding or penalising them on their performance, the situation may further worsen and that would be bad for the environment. So, what could then be the solution and the way forward?

  • Go beyond the official reported version – The data source matters and there is a need to look beyond what the companies are reporting and what the official version is. It is essential to rely on the company reported data because other sources might not be collating as much information. Although often, there are other sources as well for environment related information. They include the information disclosure as mandated by regulators and the EMAlpha algorithms scan through unstructured data to pick the unofficial information too.
  • No two ESG scores are same despite same headline figure – It is the composition that makes a big difference and all the three parameters that make up ESG need to be evaluated separately. The EMAlpha algorithms provide separate scores for E, S and G so that an investor can review the sectoral performance more transparently. Over and above, a key feature of EMAlpha’s NLP algorithms is that the attribution analysis is fairly simple and straight forward.
  • An ESG score without context and background is meaningless – The ESG is as much about intent as it is about execution. For this balanced evaluation, having an understanding of the local factors is very crucial. A very good ESG track record (probably more driven by excellent performance in E and/or S) may hide serious Governance related risks and the investors can only ignore them at their own peril. EMAlpha analysis meticulously incorporates this critical part of the ESG evaluation jigsaw puzzle.

References

  1. https://www.rechargenews.com/energy-transition/french-oil-giant-total-clashes-with-greenpeace-over-inaccurate-greenwash-claims/2-1-984976 (Accessed on 26th March 2021)
  2. https://www.bloombergquint.com/gadfly/former-blackrock-executive-tariq-fancy-blows-the-greenwashing-whistle (Accessed on 26th March 2021)
  3. https://mancunion.com/2021/03/08/is-greenwashing-by-big-tech-deceiving-us-all/ (Accessed on 27th March 2021)
  4. https://yourstory.com/weekender/sustainability-claims-fashion-brands (Accessed on 28th March 2021)
  5. https://www.emalpha.com/what-is-cooking-in-south-korea-on-esg/ (Accessed on 28th March 2021)
  6. https://www.emalpha.com/esg-matters-act-now-or-repent-later-an-analysis-of-top-glove/ (Accessed on 28th March 2021)
  7. https://www.emalpha.com/is-china-getting-rewarded-by-sustainability-focused-global-investors-for-its-progress-on-environmental-issues/ (Accessed on 28th March 2021)
  8. https://www.emalpha.com/is-saudi-aramco-prepared-for-a-renewable-future-what-do-we-know-from-the-companys-reporting/ (Accessed on 28th March 2021)
  9. https://www.emalpha.com/do-organizations-pay-more-attention-to-s-in-esg-reporting-a-critical-evaluation-of-alibaba-group/ (Accessed on 28th March 2021)
  10. https://www.volkswagenag.com/en/group/portrait-and-production-plants.html (Accessed on 22nd March 2021)
  11. https://www.volkswagenag.com/ (Accessed on 22nd March 2021)
  12. https://www.bbc.com/news/business-34324772 (Accessed on 22nd March 2021)
  13. https://abcnews.go.com/US/volkswagen-ceo-indicted-emissions-defeat-device-scandal/story?id=54922971 https://www.motorauthority.com/news/1115522_how-did-volkswagens-diesel-defeat-device-work (Accessed on 22nd March 2021)
  14. https://www.forbes.com/sites/richardepstein/2017/09/27/the-role-of-defeat-devices-in-environmental-protection-beyond-the-vw-scandal/#614b6b6652c1 (Accessed on 22nd March 2021)
  15. http://cseweb.ucsd.edu/~klevchen/diesel-sp17.pdf (Accessed on 22nd March 2021)
  16. https://www.nytimes.com/interactive/2015/business/international/vw-diesel-emissions-scandal-explained.html (Accessed on 22nd March 2021)
  17. https://www.extremetech.com/extreme/249891-vws-diesel-defeat-devices-finally-located-cracked-wide-open (Accessed on 22nd March 2021)
  18. https://fortune.com/2018/02/06/volkswagen-vw-emissions-scandal-penalties/ (Accessed on 22nd March 2021)
  19. https://www.theguardian.com/business/2019/sep/30/volkswagen-emissions-scandal-mass-lawsuit-opens-in-germany (Accessed on 22nd March 2021)

EMAlpha Products and Services

In most Emerging Markets, information discovery is a major challenge. For example, even if global investors do show interest, how do they solve the problem of timely access to information? The world’s largest capital allocators hold USD 60 trillion and they include GPIF (Japan), GPF (Norway), ADIA (Abu Dhabi), GIC (Singapore) etc. However, only 10% of the capital gets allocated to EMs and ~90% goes to G10. The big hurdle for EMs is: Foreign investors cannot access relevant local information in a timely fashion.

Most market participants and investors from across the world realise that the low rates in G10 makes EM attractive for investors. But, a) Information access is usually a cost and time intensive process for investors, and b) In many EMs, language is a big barrier and because of multiple regional languages, there is a significant delay before news makes it to the mainstream English language. To address these issues, you need solutions like, a) Real time news collection from multiple languages and, b) Instantaneous machine translation and text analytics leading to actionable recommendations for investors.

There are further challenges such as ensuring that companies behave responsibly and that they adopt sustainable business practices. There is a need to ensure that the investors are contributing towards making the world a better place by making investment decisions which reward responsible behaviour of companies. Case in point, ESG (Environmental, Social & Governance) which is increasingly being used as a filter for investment decisions. There are other issues as well such as which data to use and a lack of a standardized framework for evaluation.

Some of these issues are too important to be postponed to a later date and it is in this regard that EMAlpha is making its contribution. EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories.

EMAlpha also has solutions for Multilingual data collection and real time targeted information which are based on proprietary processes to collect relevant data across multiple markets. The coverage expands across emerging market equity, currencies and commodities and the work has also been very successful in testing the signals in some key markets for live trading strategies. This is a continuous cycle and a virtuous loop that allows for iterative improvement through AI-human feedback.

With developments in AI and technology in areas like NLP, there are considerable new possibilities to bridge the gap in information between Emerging Markets and the more Developed Markets. This is an area which is turning out to be very exciting because some of the tools mentioned were not available even a couple of years ago. This implies that the evolution in the field will only get faster as time goes on. While the Emerging Markets and the Capital Flow Conundrum is a complex one, there is now much more hope and optimism that with the usage of technology, things will only get better.

At EMAlpha, the ESG team is doing further research on why some issues like Social get more prominence as compared to others like Environmental or Governance issues. To look at specific cases in the context of ESG is a very intense yet interesting exercise and this has been an incredible learning experience for the EMAlpha Research team. The data, information and ratings are a humongous challenge for ESG and it takes time to reach to the depth of the issues as the field is evolving very quickly.

EMAlpha is making a solid contribution in tackling these challenges. EMAlpha has solutions for ESG which are practical, user friendly and although not too simplistic yet easy to use. EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories.

We strongly believe that the entire ESG ecosystem requires multiple stakeholders to pull in the right direction in order to make it operational and that will be the most critically determining factor for ESG’s success in making the corporate responsibility actually work. Most importantly, the investors should view ‘E’, ‘S’ and ‘G’ individually and should not confound issues when it comes to the comprehensive ESG evaluation. It is important to understand the right reasons behind ESG investing because this bias could hurt their investment decision making and portfolio performance.

Research Team
EM Alpha LLC

For more EMAlpha Insights on Emerging Markets, please visit https://emalpha.com/insights/. To know how you can use EMAlpha’s unstructured data and ESG (Environmental, Social and Governance) solutions for better investment decisions, please email us at research@emalpha.com.

About EMAlpha:

EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) more accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. EMAlpha works on information discovery and ESG solutions for Investors in Emerging Markets, using AI and NLP tech. Our mission is: “To help increase capital flow, in terms of FDI and FPI, to Emerging Markets by lowering information barriers using AI/NLP”. EMAlpha Products help achieve both alpha and ESG solutions and the idea is to help asset allocators, asset managers, banks and hedge funds along with companies with cost and time efficient access to relevant information. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious. Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.

Disclaimer:
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