Rethink incentives or get used to greenwashing

For as long as financial returns are the only measure of investment performance, sustainability will remain a marketing tool. But there is one way to move the dial.

Stephen Barnett, CEO

Every day, I receive a slew of articles about sustainable investing. These tend to follow one of two paths: advocacy or scepticism. For every two articles I read on exciting new product launches, there is one about a fund that has been marketed as sustainable, ethical or ‘green’ and yet fails to match an impressive marketing style with substance.

Is greenwashing marketing or mis-selling?

Greenwashing is trending. After the hype of sustainable investing (we can generate true triple-bottom-line returns!) comes the inevitable wave of scepticism that threatens the courageous work of so many industry practitioners. There is a rumbling of discontent from policymakers and purists, who believe marketeers have misappropriated sustainable investing, turning a noble intention into a marketing tool and paying more attention to assets under management than their sustainable investment thesis.

A growing minority of commentators is beginning to refer to this type of marketing as mis-selling. Asset managers that fall in this bucket have a simple line of defence: sustainability is ill-defined, hard to measure and subjective. As a result, sustainability becomes simply whatever the asset manager defines it as. A lack of transparency and disclosure across the industry further muddies these waters.

Although we become righteously indignant, gnashing our teeth when we hear of a sustainable fund that invests in oil majors or big tobacco, we should not be surprised. While sustainable investing is now the darling of global investment, the systems, processes and incentives that drive our industry have not changed.

Change will happen when incentives do

As in other industries, we are incentivised and rewarded based on our performance as individuals, funds and firms. Because financial performance is still the core focus of our industry, practitioners are incentivised to achieve financial returns, and are rewarded with a share of these returns.

I have met many sustainable investing practitioners who want to see a more considered, holistic form of investing and yet acknowledge that they are incentivised by the amount of money they make for their organisation and their clients. All too often, sustainability professionals act as a governance or risk function: a cost centre that gets in the way of the core business of making money.

So is it really any surprise that sustainability has become the domain of the marketing manager, for whom incentives are based on fund inflows rather than non-financial outcomes?

Sustainable investing has entered the mainstream, but only in oversight and marketing departments. We have not seen the mainstreaming of sophisticated and intentional sustainable investing strategies. And why would we? For as long as we reward our fund managers based on financial performance alone, sustainability will be relegated to a factor in achieving performance or an oversight to avoid regulatory or reputational issues.

Don't bank on consensus and consolidation

Nothing to worry about, some might say. This is a nascent industry. Of course it’s fragmented and messy; it’s young and growing! The bad actors will be found out! It has time to mature and establish standards and analytics that weed out the bad players. Other commentators laud the annual growth in sustainable investing, using big numbers (billions and trillions) as a representation of its momentum.

Unfortunately, however, the fact remains that incentives are unlikely to change anytime soon. Those cornerstones are firmly entrenched. So what are our potential solutions?

On the one hand, regulation could theoretically change entrenched incentives. However, non-financial outcomes are more complex and contentious than financial statements. Many outcomes are intangible and evaluating relative importance of these outcomes can also be subjective.

Another possible solution is that the industry consolidates, coalescing around a few analytics and data providers. But consolidation is a slow process, and we could end up with accepted standards that conform to existing incentives.

The problem is, both regulatory consensus and industry consolidation take time. And time is a luxury we simply do not have. We need to achieve the 17 UN Sustainable Development Goals by 2030 if we are to maintain a reasonable and assured quality of life. If we wait to achieve appropriate consensus or consolidation, our industry misses its window of opportunity to drive true global sustainability.

A call to arms for incumbents and startups

So where should we turn to find the capital, courage and speed to encourage better incentives in our industry?

The answer lies with incumbent ratings agencies and analytics providers. If one or a group of them were to provide significant capital and networks to fast-moving, high-intention startups, it could lead to a one-stop-shop for the alternative representation of investment incentives and performance.

There is clear precedent for private companies responding to market demand for ratings and standardisation. Moody’s, S&P, MSCI and Markit, to name a few, responded to demand that regulators could not fulfil at pace or scale.

The total cash sitting on the balance sheets of S&P, Moody’s and MSCI alone closes to $5 billion. Channelling a fraction of this cash into a world-class provider of standardised sustainability analytics and metrics would create a de facto industry leader. This leader would have the credibility and resources to provide robust data and analytics to drive a new articulation of investment industry performance and incentives.

Why wait?

Our industry is running out of time. There is an ever-narrowing window of opportunity before we are buried under the weight of greenwashing scandals. Incumbents must work with fast-moving and innovative startups to deliver bold and immediate action — before it’s too late.