A fixed income issuer might call its bonds green, but investors who are committed to ESG should take a closer look. We show you how to spot greenwashing.
As a growing portion of assets flows into ESG-focused funds, we’re seeing an inevitable increase in scrutiny around ESG investing. Are ESG investment managers really abiding by the principles of responsible investing? How “green” are green bonds? With the ESG investment market expanding every day, it’s important to be discerning when building responsible investing portfolios.
One of the biggest concerns for ESG investors is the concept of greenwashing—the practice of misleading investors about environmental practices or benefits. A company or municipal issuer may highlight its sustainability performance in one area in order to distract investors from its shortcomings on sustainability practices in other areas of the organization. Let’s explore what this looks like in the fixed income space.
How do some issuers engage in greenwashing?
As we discussed in a previous post, corporations and municipalities are issuing green- or sustainability-labeled bonds in record numbers, with $532 billion in global green bond issuance and $190 billion in sustainability bond issuance in 2021. An outside party may verify these labels, but the issuer often self-declares the bonds as green or sustainable without verification from an independent party. The lack of standardization around sustainable-labeled bonds demonstrates that ESG investors can’t rely on labels alone without performing additional due diligence.
Externally verified vs. self-labeled sustainable debt issuance, 2021
Source: S&P Global Ratings 2022, 2/10/2022. For illustrative purposes only. Not a recommendation to buy or sell any security.
An example of fixed income greenwashing in action is a September 2021 bond issue for a recycling facility project in Kalamazoo, Michigan. The tax-exempt bonds were intended to finance a plant built to turn more than 500,000 annual tons of cardboard and paper waste into recycled packaging. While the use of proceeds of this particular issue has environmental benefits, the plant itself has been cited for odor violations by the local community, with links to reports of sickness and increased cases of asthma and other respiratory illnesses. This is an example of an investment that should be excluded from an ESG portfolio. These bonds were designated as green due to the environmental benefits of the use of proceeds, but the issuer’s total environmental impact wasn’t disclosed to investors in bond offering documents. This demonstrates that the onus is on the investor to look at the full scope of the green investment before purchasing.
The SEC has discussed imposing more regulation for ESG funds through potential reporting and climate disclosure requirements, since the ESG investing market is still self-regulated. Until improved standardization comes to the industry, managers should rely on a proprietary, holistic research framework that can capture all material ESG factors when determining the issue’s suitability for a responsible investing portfolio. Investment managers must look at all aspects of an investment, from the use of proceeds of a specific bond issue to the environmental record of the issuer of the bonds. This rigorous approach is the best way to uncover any potential flaws in a sustainable bond issue.
In addition to evaluating the green or sustainability bond issue from the E (environmental) perspective, it’s also important to look at it from S (social) and G (governance) standpoints. Investors might consider how the issuer performs in terms of human capital management, workplace diversity, or sound governance. A green bond that may finance a sustainability initiative for a company or municipal issuer shouldn’t be included in a responsible investing portfolio if it fails on a nonenvironmental ESG factor. Examples of this could be corporations that focus on delivering clean energy solutions but face complaints of discriminatory hiring practices, or a hospital that issues debt for a green building project but has a record of negligence or poor patient experience. ESG investment managers should identify the most relevant ESG factors, commonly called key performance indicators, for each industry or sector to compare issuers with their peers.
The bottom line
Transparency along all steps of the investment process is crucial to ESG investing, from the research framework being used by the investment manager to the impact reporting provided to the end client. In order to provide the highest quality in ESG investment solutions, managers must preserve the integrity of all these elements along the way. This highlights the benefits of using a professional investment manager with a thoughtful and comprehensive approach to ESG research. Robust due diligence is key to avoiding greenwashing in ESG portfolios and delivering positive and measurable impact.