“Green” funds warned of dangerous gray areas


Forget green – gray is the new dominant color in high-level discussions of environmental, social and governance credentials for investment funds. And that’s because lawyers see vast gray areas in how asset managers verify the environmental bona fides of their products, which creates the risk of being sued.

“Here in the United States. . . regulators are hyper-focused on this concept of greenwashing,” says Amy Roy, Boston-based partner at law firm Ropes & Gray. She points to the approach taken by the Securities & Exchange Commission in May when it accused BNY Mellon of inaccurate ESG ratings, which resulted in a one-time $1.5 million settlement.

“Funds pursue ESG values ​​and investment strategies in different ways; the problem is that regulators are looking at this through a much narrower lens,” she says. The SEC has a method for sorting ESG funds into “a few very distinct buckets,” which means managers are forced “to make judgments about how to fit funds and their holdings into those categories, and define the key ESG terms – judgments that the SEC has already shown itself ready to guess”.

The case against BNY Mellon involved six investment products that didn’t even claim to be ESG funds but were found to have been covered by what the SEC called “various statements” that implied or represented “that all investments in the funds had undergone an ESG Quality Review”. Roy says “the advisor was blamed because the rating system he used did not provide [ESG] scores for each position in these non-ESG funds”.

She believes that “now and in the short term. . . many companies that end up and their disclosures [to be] an SEC focus could end up being used as an example,” the regulator thinks. “The real harm is the reputational risk,” adds Roy. “ESG is such an amorphous thing. There are so many changes going on right now in terms of definitions, rules and how they apply that everyone is probably in a situation where they are a bit vulnerable. .

Same zeal for regulatory action on the other side of the Atlantic. Norway’s consumer watchdog has threatened legal action against clothing companies that exceed their sustainability benchmarks. Similarly, the UK Competition and Markets Authority introduced a code for making environmental claims last year and said it would investigate whether consumers were being misled. Clothing, transport and consumer goods have been designated as its first areas of intervention.

Tom Cummins, a London-based litigation lawyer at Ashurst, says that while there hasn’t been much enforcement of ESG claims made by investment funds, “this is an area where the focus is increasingly on the regulatory side in terms of what lawyers advise their clients”.

“We see developments in the United States that foreshadow events in that jurisdiction,” he adds. “We anticipate there will be more activity in this area as sustainability is not going away.”

With little legal precedent to work from, investment firms in the UK are going back to basics to ensure they are protected from legal action.

“People are very, very aware of making sure the statements that are made around their approach. . . [tally with] what’s happening in the field,” says Cummins colleague Lorraine Johnson.

James Alexander, chief executive of the UK Sustainable Investment and Finance Association, is pushing the UK government to come up with a better framework than other jurisdictions and is part of a panel advising the Financial Conduct Authority on sustainability disclosure requirements and investment labels.

He argues that funds should be required to disclose “holdings that a reasonable investor might be surprised to see in a particular fund that is labeled in a certain way.”

“It’s really important to have a good regulatory framework in place that learns lessons from other places,” adds his colleague Oscar Warwick Thompson, who says the EU regulation on sustainable financial disclosure has “become mistakenly a fund labeling system” – instead of serving the larger purpose of enhancing investor protection.

The good news for investment firms on both sides of the Atlantic is that the prospect of being sued by investors, or any other private party, for ESG disclosures is quite remote for now.

“They [an investor] should establish a causal link,” Roy explains – in other words “that the fall in a fund’s share price was caused by the alleged inaccuracy or omission in the fund’s information on the ESG”. Taking the example of the SEC case against BNY, an investor filing a lawsuit would have to overcome the “missing link” of “materiality”.

“It’s hard to see how it would matter to a reasonable investor’s decision-making, if the ESG rating system scored every element of the portfolio instead of three-quarters of it, as it used to.” , explains Roy.

Cummins cites a similar hurdle in the UK: “The challenge facing the claimant is . . . showing that they have suffered a loss”. These challenges exist for claimants who have a “reputation”, such as investors in a fund, and are much greater for those who do not, such as people who argue that misleading ESG claims harm the entire planet and to all its inhabitants. “That would be pretty tough,” Cummins says. “Under English law you have to prove that the defendant owed you a duty of care. . . usually those [broad climate change] complaints have proven difficult.


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