What fake suede and the future of impact investment have to do with one another
A novel development
Something interesting happened in Italy earlier this year and we think you should know about it.
One Italian company, Alcantara, took a competitor, Miko, to court, accusing them of greenwashing. Alcantara argued that Miko, in describing its suede-like microfiber product Dinamica as “green” was competing unfairly. The accusation of “misleading advertising” was based on the EU’s Unfair Commercial Practice Directive (UCPD). Alcantara won. And Miko was instructed by the court to immediately change its marketing pitch, or face hefty fines.
If you want to learn more, google “Alcantara & Miko” and you’ll find various articles providing the particulars. The reason we bring this up here are:
- This is the first time, as far as we know, that a civil court orders a company to stop greenwashing, at the request of a competitor. And if this can happen in the world of synthetic suede, it can happen in the world of investing. And if a competitor can take the initiative, so can a customer, a regulator or another interested party. From a consumer protection point of view, that’s a good thing. But looking at the need for more innovation in the market for impact investment it may come with challenges.
- In reaching its decision, the Italian court relied on what’s known as “soft law” – guidelines and other quasi-legal instruments that don’t have legally binding force but can nonetheless be found to apply to real-life situations – in the green-suede case a “EU Commission Staff Working Document” that provides guidelines on how to implement an EU directive. This kind of soft law also applies to ESG funds, even if most banks, fund managers and even regulators may be unaware of this.
We’ll discuss both points, as well as the implications for the impact investing market.
Relevance for investors
Why is the “soft law” point relevant to investors? Well, because there’s a whole universe of rules out there that apply to ESG / impact funds, and that could be used by consumers, competitors, regulators or other interested parties to haul greenwashing financial institutions in front of a judge.
Take, for example, this document: “Compliance Criteria on Environmental Claims – Multi-stakeholder advice to support the implementation/application of the Unfair Commercial Practices Directive 2005/29/EC”, also known as MDEC, because it was developed by the Multi-stakeholder Dialogue on Environmental Claims.
Subtitled Helping consumers make informed green choices and ensuring a level playing field for business, it sets out a whole range of criteria that apply whenever “environmental claims” are made:
The expressions "environmental claims" or "green claims" refer to the practice of suggesting or otherwise creating the impression (in the context of a commercial communication, marketing or advertising) that a product or a service, is environmentally friendly (i.e. it has a positive impact on the environment) or is less damaging to the environment than competing goods or services.
In other words, looking specifically at the underlined terms, we would argue that these criteria likely apply to most ESG funds out there. Importantly, “creating the impression” is enough to qualify as a claim, these do not necessarily need to be explicit. So, what are the criteria?
There’s a whole laundry list, we’re just summarizing the main ones here:
Article 2.1 – Content of the claim: “environmental claims should reflect a verifiable environmental benefit or improvement and this should be communicated in a precise manner to consumers … should be clear and unambiguous … [and] meaningful and relevant to the environmental performance of the product … should reflect an environmental benefit beyond that which is already considered as a common practice.”
Article 2.2 – Clear and accurate presentation: “[The claim] should be presented in a way that is accurate, clear, specific and unambiguous to ensure consumers are not misled about the intended meaning … wording (…) should be a truthful and accurate representation of the scale of the environmental benefit, and should not overstate the benefit achieved … plain language should be used that is clear and easy for consumers to understand.”
Article 2.3 – Claim substantiation and documentation: “claims should be based on robust, independent, verifiable and generally recognised evidence which takes into account the latest scientific findings and methods … must have scientific evidence to support their claims and be ready to provide it (…) in case the claim is challenged … should be measured using the most appropriate methods … independent third party testing should be made available (…) if the claim is challenged… [should] communicate about environmental achievements instead of aspirations of future environmental performance… this does not prevent companies from communicating on future environmental efforts (…) if they deem this necessary or useful [but] companies should only do this when they have established a realistic plan with clear targets and timescales, involved relevant stakeholders and ensured third party monitoring of commitments.”
Why are we quoting these requirements in such detail? Three reasons:
- To show that many of the regulations meant to counter greenwashing, such as SFDR, are in many ways redundant – the rules needed to act on greenwashing already exist and, as the not-really-green-suede case shows, can be applied in a court of law.
- Perhaps more importantly, and if this document is any guide, impact funds will also need to be of the ‘impact-generating’ variety, as compared to the ‘impact-aligned’ variety. This, we believe, is demonstrated by the use of the term ‘benefit or improvement’, which suggests there needs to be a causal relationship.
- Even more importantly, launching impact investment funds that can meet all of these requirements is a very, very tall order: even banks and asset managers with dedicated resources, with true intentionality and long track records in impact investment would struggle mightily. This means even funds that deliver the real deal – genuine, impact-generating, additional, intentional impact – could be indicted for greenwashing. This is also because, while there is increasing agreement that ‘impact investment’ requires providing proof of a causal relationship, there is no consensus whatsoever on how this proof can be delivered, just a spreading suspicion that impact measurement isn’t doing the job.
We are supportive of measures designed to protect consumers, and there are enough investment products on the market that would benefit from a higher bar for evidence behind green marketing claims. Yet, we are also concerned that this kind of exceedingly strict set of requirements may stifle the much-needed innovation in the impact investment market.
In the excellent book “How Innovation Works”, Matt Ridley explains that most innovation is a “gradual process”, where often trial and error is “vital”, that “use often precedes understanding” (in other words, we often use new technologies before we know how and why they work), and that usually any successful innovation is preceded by a “pre-history characterized by failure.” Ridley says that “Innovation is … a collective, incremental and messy network phenomenon.”
If we apply the existing rules strictly to the fledgling market for impact investments, we will almost certainly not enable a messy, incremental process of trial & error and experimentation that celebrates failure as a means to learning and improvement. Instead, we are likely to stifle innovation and discourage budding endeavors to service investors with a desire to contribute to solving societal problems.
What can we do about this? In our view: education, education & education (and research).
Banks & asset managers: should not be too easily tempted by the lure of Article 8 & 9 lucre, or rely too eagerly on their ESG departments’ impact blessings; rather they should involve their investment teams and product development capabilities and engage with the academic world to educate themselves on evidence-based ways to structure impact-generating investments.
Consumers: should be able to have frank conversations with their banks and financial advisors, where it would be explained that having a substantial impact in the listed equity space is difficult, if not impossible, and that investing with impact may require a different risk/return appetite.
Regulators & judges: should read up on the impact investment literature and be informed by academics and practitioners alike, in order to focus on avoiding true greenwashing while not stifling innovation in the burgeoning impact investment market. This may require more emphasis on solid theories of change and qualitative assessment methods, rather than more binary labels and black or white classifications that fail to capture the subtle balance that needs to be struck between impact, risk, return and client interest.
Academics: should develop practically applicable impact assessment methods for investment products. Some thirty years ago, the need to make informed decisions based on the environmental impact of “physical” products (think: paper cups vs. reusable cups?) led to the development of life cycle assessment (LCA). Today, LCA is an entire science but is standardized enough to be applied by industry actors and a host of consultancies. We need “LCA” tools for investments, that set the standard for what “evidence for impact” should look like in the investing space.
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About the authors
Florian is a Postdoctoral Associate at the MIT Sloan School of Management. He explores the real-world impact of sustainable investing and how investors integrate impact into their decision-making. Besides his research, Florian serves as a member of the board of directors of ESG-AM, a Zurich-based asset manager focused on impact and sustainability. Before joining MIT, Florian did research at the Center for Sustainable Finance and Private Wealth (CSP) at the University of Zurich.
Harald Walkate is the founding partner of Route17, an independent blended finance advisory. He is also founder of Finding Ways Ahead, an ESG and sustainable finance advisory, and a Senior Fellow at the University of Zurich Center for Sustainable Finance and Private Wealth (CSP). Previously he was the Head of ESG and member of the Executive Committee of Natixis Investment Managers, and the Global Head of Responsible Investment at Aegon Asset Management.