Tackling ESG Mislabels and Greenwashing: SEC in the BNY Mellon Case

[Salini Augusty and Nikash John are 5th-year students from the School of Law, Christ (Deemed to be University), Bengaluru]

Sustainable development has progressively become a driving factor in the age of conscious investments. This ‘green factor’ is arguably exploited by corporates to misdirect investors for their gains. The environment, social, and governance, better known as the ESG, though conceived with noble intentions, has sometimes come to be an instrument to deceive investors. It is a rating system, which is now popularly adopted across the world by corporates and fund pools. The rating practice essentially depicts the sustainability of activities undertaken by firms, with respect to the environment, society, and their governance.

ESG proves relevant in corporate management and in attracting investments.  The funds and assets associated with ESG have witnessed immense growth in value in the past few years and are predicted to be valued at over $53 trillion by the year 2025. This growth is mainly driven by the increased sensitivity among investors towards sustainable development and the increased availability of ESG-compliant assets. Investors are well aware of the risks of investing in unsustainable businesses, and hence ESG-rated products are highly sought after. Unfortunately, the market for ESG assets has been adulterated by the presence of greenwashed funds and assets.

Greenwashed Corporate Activities and Funds

Greenwashed funds and assets have contaminated the market and they are alleged to misguide the informed decisions of the investors. Greenwashing refers to the deceptive practice where goods and services are portrayed to be eco-friendly on unsubstantiated or misleading grounds. This is increasingly undertaken by corporates to cater to the societal and regulatory demands for environmentally sound products and services. The absence of an adequate regulatory framework to tackle these activities has created an unrefereed playing field for misleading usage of green labels. From fast fashion industries to investment fund companies, various products tagged with eco-labels are made available to the public. The information available to the ordinary consumer is however limited to the label itself in most cases.  

The advent of ESG compliance has further increased the scope for the usage of misleading labels on corporate activities and ‘green funds’.  ESG compliance standards are presently undefined. A general understanding can be perceived from the standards laid down and guidelines agreed upon by international bodies such as International Organisation for Securities Commissions (IOSCO) and the United Nations Sustainable Development Group (UNSDG). Nonetheless, it falls within a grey area, as the concept of ESG is exceedingly wide. This has opened up the path for a large number of investment vehicles to be disguised as ESG-compliant products, often creating a misplaced feeling of environment, social, and governance sustainability in the investors.

Investors have a right to truthful information on their investments. But, most of these products and services provide no opportunity for the ordinary retail investor to investigate what really constitutes ESG compliance. The various parameters considered for the qualification as an ESG-compliant entity or product, or their performance under those parameters, are rarely available as public information. In the absence of a benchmark on what qualifies to be an ESG-compliant fund or undertaking, these labels will mislead the market participants. However, regulatory authorities have begun to tackle the issue and take appropriate actions against such wrongful activities. The US Securities Exchange Commission (SEC), as a first step in the right direction, has taken penal action against the misuse of ESG labels by BNY Mellon.

BNY Mellon Case

The BNY Mellon case brings to light the role that securities regulators can play in effectively dealing with the menace of ESG mislabels and greenwashing. BNY Mellon is an American financial service provider that is engaged in providing investment advice and fund management. The company had managed certain mutual funds from 2018 to 2021, over which it had claimed that an ESG quality review had been undertaken on all its investments. However, the company had failed to undertake the quality review in accordance with its claims. It had made investments in some cases without conducting the quality review and ascertaining ESG quality review score, but its investors were misled to believe otherwise.

In the instant matter, the securities regulator rightly stepped in to remedy the situation. The Climate and ESG Task Force of the SEC charged the company for the misstatements and misleading the customers who rely on ESG considerations to make investment decisions. BNY Mellon was ordered to pay a penalty of $1.5 million to settle the matter and take all requisite measures to correct the situation. The penalty levied was the first of its kind taken against ESG-related misconduct in the market. This has paved the way for holding financial service providers accountable for their misleading statements and omissions. It rightly places the responsibility on institutions to provide accurate and honest information to the investors regarding the ESG label and its content.

These measures reaffirm the need for regulatory guidance to effectuate penal actions against transgressors. Similar investigations are being undertaken against Goldman Sachs in the US, and Deutsche Bank in Germany. Both are being investigated on various claims of misrepresentation and misuse of the ESG labels. Such actions can greatly contribute to deterrence in the market regarding misuse of ESG labels. However, in the absence of a regulatory framework, action can be taken only on the grounds of inadequate or misleading disclosures to investors.

ESG Regulation

Standardization of ESG reporting and disclosures can greatly ease their administration. But the difficulty lies in ascertaining a standard format for the same. Various factors have to be considered in an ESG quality review, and they vary immensely depending upon the industry, culture, demography, society, and other relevant factors, which add to the complexity. Presently, various companies rely on third-party rating agencies or self-established standards for determining the ESG quality and rating. These entities also lack supervision, although the Securities and Exchange Board of India (SEBI) has recently consulted on regulating ESG rating providers in the securities markets.

Disclosure obligations have to be made more stringent. Blatant misrepresentations and omissions by companies and fund managers with respect to ESG compliance have to be punished to protect the investors. Even so, this does not guarantee investor protection. Although investment schemes contain information and various disclosures, they do not provide clarity on all required details such as the review criteria, investment strategy and third-party ESG scoring standards. The availability of this information will enhance the decision-making power of the investors. Further, it induces corporates to demonstrate higher sincerity toward sustainability goals and take active steps to attain better ratings.

Conclusion

In the absence of uniform or standardized reporting, and adequate regulatory guidance, the retail investors would continue to face the risk of deceitful practices of mislabelling and greenwashing. It is therefore important that adequate benchmarks are established by authorities to protect the interests of the investors and to prevent ESG malpractices. Across jurisdictions, the securities market regulators are powerful entities with vast responsibility. The penal actions taken by the SEC may guide other securities market regulators to counter the issue of ESG mislabels. Adopting ESG compliance can make businesses and, in turn, the economy, resilient in the long run.

Salini Augusty & Nikash John

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