What is greenwashing?

Investors and companies of all industries have been increasingly aware of the vital role that

Environmental, social, and governance (ESG).

In achieving financial sustainability and aligning with corporate value, value creation is key. Greenwashing, which capitalizes on the growing interest in sustainable investing, has become more appealing to investors.

Greenwashing, despite being a significant problem for today’s market is magnified by the fact it is so 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.

“What is greenwashing?” is the result of the absence of a consensus answer. A similar lack of consensus about ESG–and its limitations–is what causes the “what is greenwashing?” question. Although subjectivity regarding ESG can be natural and not inherently problematic, it can lead some to disagree with the framework in its application to greenwashing.

What is greenwashing, you ask?

“Greenwashing” refers primarily to branding or claims that portray sustainability. However, they do not follow through on the promises or statements made.

Although greenwashing is defined as a narrow set of behaviors, the label can often be applied to many items outside this specific range. This is not due to a problem of the language used for greenwashing. It’s a problem of investors understanding ESG. ESG investing may be subjective. It is easy to mistake certain parts for greenwashing. However greenwashing can be described in enough concrete terms that it works for all ESG investor types.

Greenwashing: Examples

Greenwashing can occur from target companies or investors, but most of the most notable cases originate in the corporate sphere. BP’s rebranding of itself to “Beyond Petroleum” was a well-known example. This was followed up by the installation of solar power at their gas stations. Also, claims that they would now be focusing on low-carbon products. ClientEarth, an environmental organisation, revealed that BP directed over 2,000 projects.

In 2019, 96% devoted their annual budget to oil and gaz.

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Windex’s 2019 claim about its bottles being made with 100% recycled marine plastic is another example. This greenwashing case was challenged by a 2020 lawsuit, which proved that none the plastic used to produce the bottles had ever been in oceans. These samples prove that greenwashing can also manifest in misleading branding, as well misdirection through explicit forms such as false campaigns and statistics.

ESG philosophies as well as greenwashing

ESG can mean many things to different investors. These differences manifest in ESG portfolios that are very different but still valid. ESG consulting, ESG private equity and other related fields. ESG is closely related to greenwashing. However, there are many interpretations for this practice. The greenwashing concept is not new, but it has many different interpretations.

Definition of ESG

Although it is well known that there are many factors that affect an investor’s view of and approach to the stock, this spectrum can be simplified into three main points. This broad spectrum of perspectives can be summarized into three main themes

ESG Philosophies

These three facets of ESG will determine where an investor is located.

  • Tolerance for ESG-related risks beyond control
  • Offensiveness to companies that haven’t made significant efforts for managing ESG risks
  • Personal threshold for what constitutes ESG.

ESG purists

ESG purists take very little risk considering the factors listed above. This will show in an investment approach that favors companies in green sectors, such sustainable agriculture, alternative energy, healthcare tech and other industries that perform well with respect to ESG. Purists can see ESG in other ways than they do.

ESG pragmatists

ESG pragmatists can take on more risk and are open to investing in larger amounts of companies. Their investment profiles often include industries that are not explicitly green or sustainability-focused but also avoid inherently harmful industries. As a majority of their sustainable investment is rooted within risk management and mitigation, they define “greenwashing” as investing in companies with unmanaged potential risk under the pretext ESG, but not doing any remedial action during their holding period.

ESG pluralists

ESG pluralists employ the broadest interpretation possible of ESG in their investment strategy. ESG pluralists believe that investments into traditional high-risk industry like oil, coal and gas, or tobacco companies with substantial unresolved managed risk can still qualify if they work together to reduce these manageable risks. This is why a pluralist would call greenwashing investing in high risk companies with no intention to increase or mitigate them during their holding period.

How greenwashing affects investor returns

Greenwashing can hide a company’s ESG deficiencies and lead investors to take on more risks than they may realize. An investor might unknowingly support a company which hides its ESG risk management deficiencies and doesn’t follow through with sustainability claims. Investors could be set up to fail to fulfill sustainability quotas or mandates, which can skew the balance between actual and anticipated risk calculations.

Indirectly, the risk of greenwashing has led to a substantial decline in investor confidence and support for sustainable investing. This not only makes them less willing to take advantage of opportunities but also decreases the perceived credibility and legitimacy of ESG, which hinders widespread adoption.

These adverse effects are also felt by companies that actively manage their ESG risks. They run the risk to be accused of “greenwashing” and have their assets resold. These negative effects continue to affect green investment funds and traditional, “cleaner” investments.

Sustainable investors backing it

While companies with higher risk, whose performance may be significantly improved by shareholder input continue to stagnate

How to identify and avoid greenwashing

The danger of greenwashing has led to mistrust between GPs, LPs and target companies. However there are ways you can navigate these conflicts and avoid them.

The first step for investors is to

Greenwashing is a red flag that can be avoided.

An important step in understanding one’s ESG philosophy and being able to adapt to other philosophies is to get to know your fellow investors. Recognizing there are many valid ESG philosophy that can all make a difference in social and environmentally-friendly improvements can open up more possibilities and keep investors from being misled about greenwashing.

Understanding the ESG philosophy of oneself can facilitate discussions between parties. It also helps to prevent mismatches in expectations. This can help investors align themselves and others with similar ESG/greenwashing beliefs, or at minimum explain a specific decision that was made to other stakeholders.

Diverse ESG philosophies can be of great value

Greenwashing is often a topic of controversy among investors. But it has an unmistakable impact on the reputation of investors and consumers. It can influence what companies they invest and how they view portfolios. Although they can cause confusion, differing ESG philosophy are actually a good and desirable thing. This is because broader interpretations encourage ESG innovations in a wider range industries, not just the ones that are already considered sustainable.

Understanding ESG philosophies can help you to prevent conflict and mismatched expectations. It will also make it easier for you to have a more secure and productive investing experience.

Check out our analyst note for more information on greenwashing and ESG.

ESG, Impact, & Greenwashing In PE and VC

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