Could greenwashing legislation do more harm than good?

Capital growth and safety are top of most investors’ priorities. But doing this ethically matters, too. That goes beyond just complying with regulations; many ask whether a business actually makes a positive impact on the world. Now regulators are weighing-in. Soon, new rules will be imposed, forcing stockmarkets to step-up in addressing climate change and sustainability. This will radically change investing; but the new rules might do more harm than good.

The challenge is that doing good goes beyond climate change and counting carbon. Society has a wide range of aims that it wants supported by the right corporate behaviour. And it matters for society that investment adds to economic efficiency. The role of stockmarkets in correctly pricing and allocating capital, allowing good economic decision-making across the economy, should not be underestimated. The process of raising finance - along with takeovers and mergers - involves investment analysis, and drives resources towards better services and management.

In recent years, many investment analysts have already been factoring sustainability into their company assessments. There is currently flexibility in how this is done, with investors also being able to access a wide range of fund approaches. But regulation is planned to codify this, forcing uniformity. There is consultation on the plans, but already some have pointed out the possibility of unforeseen consequences.

The UK financial regulator, the FCA, has set out proposals for a new regime that is likely to start next year. Stopping investment managers and their products from “greenwashing” – making dishonest environmental claims – is to be applauded. The new rules will be a very prescriptive approach, bundling investment products into a limited number of approved buckets, and specifying how those are labelled. Certainly, there is already much consumer confusion about how best to help the planet and make investing sustainable, but there is danger in backing a single solution.

There is evidence that the stockmarket is not yet fully pricing-in climate risks, with a need for political intervention. But the consensus ends there, with no agreement on the way forward. As carbon fuels will still be needed for many years to make things - including all the infrastructure that implements alternative energy - there may be value in helping the major oil businesses to transition.

Even the science of net zero does not have consensus. Are carbon offsets genuine, or might they simply be short-term fixes? How can we correctly calculate the lifetime impact of a product or activity? It is also not clear exactly where the boundaries of responsibility lie. Direct carbon emissions by a company may only represent some 20% of its total impact when taking into account the emissions created by its suppliers or even by its consumers as they use the product.

The difference in approaches is also evident in the way in which the European Union is legislating, which does not match the UK’s plans. All of this may end up restricting consumer choice, as global and Pan European investment organisations might not be able to offer the same range of products in the UK, that they sell in the EU. And British investors who have made an early move into supporting funds that they believe are doing good, might end up receiving warnings that their funds do not fit the new labels. This opens room for argument between investors, financial advisers and fund managers as to possible mis-selling. Something aimed to help consumers navigate the market might well add to confusion.

Some standardisation in the UK and internationally is to be welcomed, but the stockmarket cannot solve the problem by itself and it might be better to allow a degree of flexibility in pursuing sustainability. British investors seem set to lose some choice. Investors should think beyond the labelling to pick the funds and types of company that they do believe are working to solve problems.

A version of this article was published in The Herald on 18.2.2023.

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