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Forget Greenwashing – Whitewashing is what we should worry about

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By Wolfgang Kuhn

· 15 min read

Ok, don’t forget greenwashing altogether, that was just to sound controversial. But seriously: Whitewashing is much bigger. By ‘whitewashing’, I mean: financing non-green economic activity, activity that has a negative impact on planet or people, without being called out. Whitewashing trumps greenwashing. Let’s come back to that in a little while.

Positive impact

These days, everyone wants to have impact. Investors are no exception. We want bang for our buck, not just reshuffling the deck chairs. We want to affect real, measurable, significant change. While making a decent return, of course. But that bang better be real. Otherwise, someone will shout “Greenwashing” before you can say “Mississippi”. For the bang to be real, it needs to be ‘real-world impact.’ That’s what they say. The FCA’s brand-new labelling guide to fight greenwashing uses the term 16 times. Even the conservative CFA Institute, in its latest member survey, asked “How much progress do you expect investment organizations to make towards achieving real-world impacts on environmental and social activities in the next 5-10 years?”

That is all well and good. Of course, greenwashing is counterproductive. Of course, retail investors need to be protected from mis-selling. And, of course, we need as much positive impact as possible.

Negative impact

The danger is that we focus too much on one type of impact, forgetting the other one. Because, you see, your investments already cause real change. Only unintentionally, as a by-product of your assets making money for you, and usually adverse to planet or people. Whatever we do as humans, it is rarely good for the environment in the first instance. Carbon emissions. Water pollution. Animal habitat loss. Microplastics. And so on, you know the list. Social is a bit different, as economic activity tends to have inherent social benefits. But adverse social impacts are nevertheless in abundance: violation of human and labour rights – discrimination, inhumane wages, child labour. You know that list too.

Why am I concerned that we forget about these negative impacts? Why would we, how could we? We are constantly reminded of them, aren’t we? Surely they are what Sustainable Finance is all about? The EU’s Sustainable Finance Disclosure Regulation will shortly start forcing EU asset managers to report on their adverse impacts. So what is the problem? Here it comes: Sustainable Finance is getting too focussed on the positive change that one’s money brings to the world.

A line of thought promoted by Sustainable Finance academics and think-tanks holds that only if a causal relationship between the money flowing and the world changing (positively) can be proven; only then can the investment be said to have real-world impact. Other investment activity, so this line of thought, is not meaningful when addressing sustainability problems. Only if you can prove that the thousand Euros that you hand over to someone in a financial transaction is directly causing carbon to be sucked out of the air, or a particular species’ habitat to expand, or the average life expectancy of a particular community to increase; only then do you have real-world impact. Standard investor action, buying and selling, is mostly irrelevant. Ex-ante exclusions of polluting companies’ securities: irrelevant. Trading in the secondary market: irrelevant, because there is no direct cash effect on the company.

Depending on whom you ask, real-world impact also has to have intentionality and/or additionality. If you do not mean to make a green investment, there is no intentionality and the investment cannot be said to have impact. You really have to mean it. If you refinance something that is already in existence, your investment has no additionality, and again, you can’t claim to have real-world impact. So even if you were to provide long-term funding for a brand-new windfarm, but your bank provided you with interim finance for just a few days, you are out of luck: the bank gets to book the impact, not you.

The definition put forward is that of impact as “change in a specific social or environmental parameter that is caused by an activity.” That sounds reasonable enough, until you realise that the nuance is lost in the conversation: when humans claim to have caused change, what they usually mean is that they have reduced something negative that was already happening. Like helping reduce carbon emissions. This, mathematically, is the second derivative, the change to the change already happening. Nothing wrong with looking at the second derivative. But we shouldn’t forget about the first. Doing so leads to the absurd situation where investors set decarbonisation targets for a part of their portfolio only (39% in the case of the members of the Net-Zero Asset Manager Initiative NZAMI), either not knowing or not bothered about what the other part (that would be 61%) is financing.

The real-world-impact argument allows academics to give it to sustainability activists, who started advocating for divestment long before it dawned on the scholars of finance that sustainability might be worth studying. The financial industry loves real-world impact, because investors don’t want to be told by pesky activists what they can and can’t be invested in. And, finally, it allows financial regulators to busy themselves with the relatively straightforward problem of consumer protection without having to tackle the not-so-straightforward problem of environmental and social degradation as a matter of financial stability.

To separate the good from the useless, academia has come up with the differentiation of ‘impact-aligned’ vs ‘impact-generating’. They don’t quite put it that way, but impact-alignment is really only to make the investor feel good about themselves. To do good, so the thinking, you need to choose impact-generating investments. The Principles for Responsible Investment happily promote this differentiation on their website: “Divestment reduces investors’ ability to directly influence the sustainability performance of investees." But when Ukraine was invaded, they felt compelled to add a disclaimer. In the light of events, claiming that divestment or exclusions are pointless in principle must have become untenable.

‘Investor-impact’, according to another view, only comes through engagement activity, or in cases where capital allocation leads to a “change of a company’s activity level”. Additionality of sorts.

Shaping a portfolio of financial assets through buying and selling is considered pointless; real-world impact proponents insist that „there is no robust evidence that aligning a portfolio with a given vision for the wider economy (…) or according to a general set of principles (…) is a compelling proxy for the real economy changes required to deliver that vision.“But – so my observation - there simply can’t be any empirical evidence for how individual portfolio actions lead to systemic change that hasn’t yet happened. Not until it is too late, anyway. Impact aligned, impact generating, investor impact, these are interesting concepts, and possibly useful when thinking things through. And we do need to think things through a lot. But I get very nervous when they are suddenly held up as scientific truths; as “science-based”.

A word on the real-world impact of engagement in practice.

The engagement chestnut

Engagement (together with voting an element of stewardship) has become the weapon of choice of Sustainable Finance to affect change. And you can see why that would make sense: Investors, who usually either have the right to vote on company management, or at least have the capability to withhold financing, those investors have power. The more investors, the more power. If you want to affect change, this is the sword you want to wield. Which is true, only that it isn’t done. Take Climate Action 100+, the “investor-led initiative to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change”. After five years of engagement, and despite almost USD 70 trillion in assets under management, out of their 166 target companies, “only 20% have established ambitious medium-term targets that cover all material scopes and are aligned with a 1.5°C pathway.“ One clear objective, 70 trillion dollars of voting rights, and only some 30 companies are even willing to make plans for decarbonisation.

Either engagement doesn’t work, or it isn’t done properly. If you claim that it is ridiculously superior to divestment, then you have to go with the latter. It isn’t hard to see why engagement as it is practiced doesn’t work. The ambition is too low. Too much talk, too little pushing. Tea-and-cookies chat instead of forceful demands. No genuine collaboration. No-one wants to rock the boat too hard. The investment still needs to generate cutting-edge returns, after all.[1] No wonder investors and banks love engagement. They can keep their investment and lending portfolios as they are, don’t have to forgo lucrative opportunities, and get to claim impact all the same. Investor impact. Real-world impact.

Justification for inaction

Real-world impact requires that you can show causality. As if the world was a 19th century machine, only subject to the laws of mechanics, where cause and effect are easily explained by a sequence of cog wheels (see Figure 1).

Figure 1: The marvellous real-impact machine. Source: Author

But showing causality in the real world is tricky. In order to prove a causal link between money-flows and real-world events, even to just get to a standard of ‘beyond reasonable doubt’, you need lots of effort and data, and even then, “it is often more honest and realistic to—instead of seeking to prove a causal link between an action and an effect beyond any doubt—speak of a plausible association.”

OK, if you really want to show causality, you can probably do it. But what if you don’t? What if you want to hide it?

Because the argument cuts two ways, you see. If we make impact attribution a matter of scientific purity, then what will stop someone not so keen on the causal link between their actions and a particular negative impact from invoking the same scientific purity? “You can’t prove that, there is simply not enough data!” If we get used to setting up exceptionally high bars in order to prove positive real-world positive impact, how can we ever keep those bars from being raised for negative impacts as well?

Don’t worry if you have lost me there for a second. Because this is where the financial industry provides plenty of examples. You will hear the following: “Selling shares in a coal miner would not physically reduce CO2 emissions, so why ask me to do it?”. “Our business relationship with this oil company does not breach our climate policy because we provide general corporate-purpose lending and there is no direct link between our lending and the borrower’s exploration activities.” Or the old additionality trick: “If I pull out of the lending to oil sand extractors, someone else will step in, and there won’t be any real-world impact.”

Focussing exclusively on real-world change makes the divesting of assets irrelevant, even counter productive. You could be doing more greenwashing by selling a fossil-heavy issuer from a portfolio than by holding same issuer and taking dividends, as long as you engage. And because divesting has no real-world impact, it makes no difference what you hold in your portfolio, either. The link between the financier and the polluting activity is lost. Now there is nothing for the financier to do but talk about the new products that purportedly do have impact. Real real-world impact.

The curious irrelevance of secondary markets

If divestment is not a thing, then secondary markets – the markets where one sells the assets one doesn’t want to hold - have no role. This dismissal is a peculiar one. The place that gives our economy its name; where the price for capital is formed; where CEOs’ remuneration is determined; where the health of companies, sectors and whole economies is monitored in real-time: this place is supposed to be irrelevant when it comes to changing the world’s future?

I blame central banks (I do that often). Most of Sustainable Finance came into being after Quantitative Easing (QE) had taken a hold. No-one can remember that secondary markets once gave signals of risk, before central bankers decided to eliminate risk premia as part of their monetary experiments. No-one remembers the investor’s fear of not being able to get a position away; of a company not being able to raise equity during a crisis. QE has simply convinced everyone that the supply of non-green capital is infinite. No wonder that investors aren’t too worried about stranded assets. Presently, things are changing a bit. But the dominant ideas in Sustainable Finance that have formed through QE will linger. Secondary markets do not matter.

The balance sheet needs no causality

Now, while it is obviously true that a secondary market trade doesn’t directly affect the cash position of a company, this is an all too narrow focus on cash flow. Finance isn’t just about cash flow. We need to go back to what double-entry bookkeepers have known since the 15th century: economic activity happens through balance sheets: one side for assets, one for liabilities and equity. One side exists with the other: One coin, two sides. Where there is an asset, there has to be equity or a liability. And still: one side can change without the other. Assets can be swapped, liabilities extended.

What this means for our discussion is this: you don’t have to consult the laws of physics, looking for financial atoms on the liability side of the dividing line crossing over to the real-world side, mechanically triggering real world impact. By holding a financial asset that represents part of a company’s right side of the balance sheet, you are on the hook: There is a link between you and the assets on the left side of that balance sheet. True: Divesting will not magically reduce the underlying activities’ footprints. It won’t even take away your involvement with the footprints while you were linked to those footprints through your investment. But it will allow you, the investor, to break the link with those footprints going forward. That won’t bring immediate, visible results on an individual basis. But this is how it starts.

Greening finance or financing green

Just to deal with the climate crisis, we have to come up with USD 4 trillion in annual finance flows by 2030. And USD 125 trillion by 2050. We can try to get that kind of money by making Sustainable Finance the focus of green, real-world impact certified investing. That, though, will pretty much leave us with project finance and engagement. Even if you throw in green and SLB bonds, significant monies will still have to be reallocated away from the dark side. “There is enough liquidity in global financial markets (USD 200 trillion held by investors in 2020) but barriers impeding deployment exist.”

But even if we could find enough money without reallocation: we won’t halt the multiple crises we face if we continue to finance environmental and social degradation at the same time. If we keep polluting while we build all the green infrastructure that is needed, net positive change will be glacial. We will end up with sustainable finance as a subset of otherwise non-sustainable finance (see Figure 2). Not massively appealing, is it?

Figure 2: Sustainable and Unsustainable Finance. Source: Author

A link that creates responsibility

What to do? The link between finance and economic activity needs to be brought back into the spotlight. Its meaning needs to be understood: creating responsibility. Because these links come with remuneration (dividends, coupons, capital appreciation, carried interest, whatever). If you finance it and derive benefits from it, you are responsible for it. Period. No causality needed, just cui bono. And investors and banks need to be reminded of that responsibility. Constantly.

It will not solve all problems immediately. If you don’t finance something, someone else may. But someone else then takes on the responsibility. And will be reminded of it. Constantly. What the consequences of that responsibility will be is for society to define. Disclosure obligations at first. Revocation of the social license to operate later. Denying that this link exists is what I call ‘whitewashing’, and an economy with a lot of whitewashed capital is under threat.

Someone will say: This is just a throwback to old-fashioned Socially Responsible Investment, SRI. I agree. If finance wants to be sustainable, we need to go about it in a more old-fashioned way, not trying to pretend that everything can be thought of as a win-win. This is what double-materiality is about: taking responsibility for your actions.

At this point, I get really worried. Because ‘responsibility’ smacks of ethics, of morals. Mention ethics to a hard-headed financial practitioner with a fiduciary duty, and they will scoff. Ethics happens to be a significant part of the CFA curriculum, but the concept apparently is only meant to apply to your behaviour, not to what you invest in. There are still plenty of people who believe that individual profit maximisation will lead to the best outcome for society: Markets will always yield the optimal result, unless they fail, which then is due to governments getting policy wrong. That is for lawmakers to sort out, not markets. Of course, you can take that approach. “Saving the world is voluntary”, says Thunberg. But society can’t afford that much longer, so saving the world inevitably will become less voluntary for investors. They will have to grow up. No-one forces you to care about your footprint, which doesn’t mean you shouldn’t. In every-day life, there are always forms of anti-social behaviour that are not illegal, but which mature people would stay clear of. Investors have to understand that in an age of systemic connectedness, the border between morality and self-interest is becoming more and more fluent by the day. Fiduciary duty is not what it once was. Unless we believe that the whole USD 125 trillion will offer super-competitive returns (a win-win for everyone), we will need to ask that maturity from investors. Because when it comes to systemic crises, fiduciary-duty-profit-maximisers act like kids in a toy store, while real school kids nowadays often show the wisdom of grown-ups. We need investors to act like grown-ups as well, take responsibility and clean up their mess after them. We need that from all of them, not just the ones with public assets. The fact that the pricing of externalities is not required by law does not take away that responsibility.

I agree with those who say that we can’t wait for finance to grow up. The problem, though, is that government intervention is not exogenous, but heavily reliant on what actors in finance think and lobby for. So whichever way we want to go, through markets or governments, we won’t get around pushing finance to become compatible with society.

We can stop all greenwashing and still not have halted global overheating and other pending disasters. Whitewashing is the opposite of taking responsibility for financed emissions, and it needs urgent attention.



illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem.

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About the author

Wolfgang Kuhn is an independent consultant focussed on financial markets’ efforts to become sustainable. He worked as Director of Financial Sector Strategies at London-based campaigning group ShareAction. Wolfgang had been an investor in credit and government debt markets for nearly 20 years.

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