Investors and companies across industries have increasingly recognized the important role that environmental, social and governance (ESG) risk management and value creation play in achieving financial sustainability, aligning with corporate values, and pleasing stakeholders. However, with the continued growth of sustainable investing, greenwashing has become an increasingly attractive strategy to capitalize on the demand for sustainable companies and portfolios.
Though greenwashing is a significant challenge facing today’s market, it is made significantly more acute by the fact that the phrase is commonly misused. This makes it difficult to differentiate genuine greenwashing from false flags, which complicates the investing process and obscures good opportunities—greenwashing itself may be a stubborn problem, but its misidentification can be easily remedied through a better understanding of ESG.
Ultimately, the lack of a consensus answer to the question “what is greenwashing?” stems from a similar lack of agreement about what ESG is—and what it isn’t. Though subjectivity surrounding ESG is natural and not inherently a problem, it can lead to conflict among those with different perceptions of the framework as it pertains to greenwashing.
What is greenwashing?
The term “greenwashing” refers to branding or claims that project an image of sustainability, but not following through on the efforts stated or implied by those claims.
As evidenced from this definition, greenwashing represents a specific and contained set of behaviors, yet the label of greenwashing is often applied to many things outside of this range. What this reflects is not a problem with the language of greenwashing, but rather a problem some investor’s understanding of ESG. ESG investing can be somewhat subjective, leading some to misrepresent certain parts of it as greenwashing, but greenwashing itself is defined in sufficiently concrete terms to work for all types of ESG investors.
Examples of greenwashing
Greenwashing can originate from both investors and target companies, but some of the most well-known cases come from the corporate sphere. A commonly cited example was BP’s rebrand to “Beyond Petroleum”, which was followed by the public-facing implementation of solar panels at their gas stations and claims that they would shift their focus towards low carbon products. This effort was later discredited after environmental organization ClientEarth exposed that BP had directed over 96% of its annual spend towards oil and gas in 2019.
Another greenwashing example was Windex’s 2019 claim that its bottles were produced with 100% recycled ocean plastic. This instance of greenwashing was challenged during a 2020 lawsuit that proved that none of the plastic used in production had actually ever been in the ocean. As evidenced from these samples, the practice of greenwashing can manifest both in misleading branding and more explicit forms of misdirection such as false statistics and campaigns.
ESG philosophies and greenwashing
ESG means different things to different investors, manifesting in very different looking, but still legitimate ESG portfolios and fields like ESG private equity, ESG consulting and other related areas. Being closely tied to ESG in recent years, greenwashing similarly experiences many different interpretations. Though the definition of ESG is a known quantity, there are many factors that influence an investor’s outlook on and approach to it. This spectrum of perspectives can be simplified into three main ESG philosophies, which are largely determined by where an investor falls on these three facets of ESG:
- Tolerance for unmanageable ESG risks
- Openness to companies that have not made significant efforts to address manageable ESG risks
- Personal threshold for what constitutes “doing ESG”
ESG purists
ESG purists have a very low risk tolerance where the factors above are concerned. This will manifest in an investment pattern that skews heavily—if not entirely—towards companies in green industries, such as sustainable agriculture, alternative energy and healthcare tech, that are already performing well with respect to ESG. Given their narrow perception of ESG, purists are likely to perceive other interpretations of the term as greenwashing.
ESG pragmatists
ESG pragmatists have a broader risk tolerance and are willing to invest in a greater sample size of companies. Their investment profiles often include industries that are not explicitly green or sustainability-focused but also avoid inherently harmful industries. Since much of their sustainable investing is rooted in risk management and mitigation, they define greenwashing as investing in companies with unmanaged risk under the pretext of ESG, yet not doing anything to address it during their holding period.
ESG pluralists
ESG pluralists apply the broadest interpretation of ESG in their investment strategy. They believe that investments in traditionally high-risk industries like oil, coal and gas and tobacco or companies with substantial unresolved manageable risk can still qualify as ESG if they work to improve manageable risks as a shareholder. Given this approach, a pluralist would define greenwashing as investments in high-risk companies with no intent to improve them or mitigate said risks during their holding period.
How greenwashing affects investors
Greenwashing can obscure a company’s ESG deficiencies, leading investors to take on more risk than they may be aware of. By backing a company that hides its poor management of ESG risk factors and doesn’t follow through on sustainability claims, an investor may unknowingly set themselves up to fall short of sustainability quotas and mandates, skewing the balance between expected and actual risk calculations.
As a more indirect consequence, even so much as the possibility of greenwashing has contributed to considerable erosion of investor confidence in sustainable investing. This not only makes them more hesitant to take opportunities but also reduces the perceived credibility of ESG, stymying the widespread adoption of the framework.
These adverse effects also extend to companies in the process of actively reducing their ESG risks, since they risk being accused of greenwashing and written off. As a result, green investment funds and other more traditionally “clean” investments continue to be backed by sustainable investors, while higher-risk companies, whose performance could significantly improve with shareholder input, continue to stagnate.
How to identify greenwashing and avoid miscommunications
The threat of greenwashing has created a certain degree of mistrust and miscommunication between LPs, GPs and target companies, but there are ways to successfully navigate or avoid these conflicts.
The first step investors should take to identify greenwashing and avoid false positives is to develop a strong understanding of their personal ESG philosophy and the ability to accept the philosophies of others. Recognizing that there are many valid ESG philosophies that can all contribute to social and environmental improvements can open more opportunities and prevent investors from making unfounded accusations of greenwashing.
Knowing one’s ESG philosophy can also facilitate discussions between parties and go a long way toward preventing mismatched expectations. This can either help investors align themselves with others who have similar ideas of ESG and greenwashing, or at the very least serve to explain a specific decision to other stakeholders.
The value of varied ESG philosophies
Though the definition of greenwashing can be a subject of debate amongst investors, it undeniably has a reputational impact among investors and even consumers, influencing what they invest in and how they view companies and portfolios. Though they can at times be a source of miscommunication, differing ESG philosophies are actually a positive and desirable phenomenon, since broader interpretations encourage ESG improvements in a wider range of industries, not just those that are already seen as sustainable.
Understanding ESG philosophies, greenwashing and the interplay between the two can help prevent mismatched expectations and conflict between parties, leading to a more secure and effective investing experience.
To learn more about greenwashing and the ESG philosophies, read our analyst note, ESG, Impact, and Greenwashing in PE and VC.
