The Financial Inclusion Centre has published a new discussion paper setting out its concerns about social impact washing in the financial sector. The new paper can be found here. FIC Preventing social impact washing 0423
As part of its work on the environmental, economic, and social utility of finance, the Financial Inclusion Centre recently published a major report called The Devil is in the policy detail – will financial regulation support a move to a net zero financial system?[1]
We concluded that current climate-related financial regulation would not align financial markets with net zero goals. The FCA’s Sustainability Disclosure Requirements (SDR) and sustainable investment label initiative[2] is confused and confusing. It is unlikely to be effective at exposing funds that finance climate harm or preventing greenwashing.[3] We also highlighted the weaknesses in ESG ratings.
That report focused on environmental issues. However, we were also concerned that social impact washing[4] has not received the same degree of scrutiny as its ‘twin’, greenwashing. The FCA’s proposals on SDR and sustainable investment labels are nowhere near robust or clear enough to prevent social impact washing.
The whole approach to ESG ratings promoted by policymakers, regulators, and the industry is fragmented and inconsistent. It is too narrative based which allows for obfuscation on the part of funds and asset managers. ESG ratings providers are not regulated and ratings methodologies can produce very different results for the same financial institutions/products. There are too many opportunities to game the ESG ratings market to overstate how ESG compliant products are.
For too long, policymakers and regulators have let the market determine the evolution of sustainable finance and ESG products and ratings. Is it too late to get at least part way ‘back to basics’, and to introduce some discipline and rigour? Let’s hope not.
On the environmental side, the focus should be on hard data (independently verified) on the amount of climate damage financial institutions are enabling, with a clear data-based, rating system.[5] This is crucial if the financial sector is to be held to account for enabling climate harm.
On social sustainability, the goal should be to expose the degree of ‘social harm’ enabled by funds and identify funds that make a genuinely positive social impact. The FCA should apply strict criteria to prevent social impact washing.
For example, we argue that only financial institutions willing to sacrifice financial returns in pursuit of social goals should be allowed to describe their funds and products as socially sustainable. Similarly, funds investing in companies that treat workers fairly or pursue progressive polices on gender pay equality should not expect any special praise. Doing what is expected should be the norm.
This paper sets out our concerns about social impact washing using illustrative case studies and proposes an alternative disclosure and rating system to hold financial institutions to account. We would welcome views on what we set out here.
[1] The Devil is the policy detail – will financial regulation support a move to a net zero financial system? | The Financial Inclusion Centre
[2] FCA updates on its Sustainability Disclosure Requirements (SDR) and investment labels consultation | FCA
[3] In simple terms greenwashing refers to organisations making misleading claims about the positive contribution a fund/ product makes to the environment, or indeed downplaying the negative impacts on the environment.
[4] Social impact washing relates to organisations making misleading claims about the positive contribution a fund/ product makes to social goals (improving workers’ rights, tackling gender inequality etc), or downplaying the negative impact.
[5] For example, a colour coded system or 1 – 5 stars based on the degree of climate harm being financed. The Portfolio Greenness Ratio outlined by the European Securities and Markets Authority (ESMA) provides a useful template ESMA 50-165-2329 TRV Article – EU Ecolabel: Calibrating green criteria for retail funds (europa.eu) The FCA’s own analysis shows that objective grading systems influence investors’ decisions In this case, a medal based system – bronze, silver, gold – was tested. See: Sustainable investing: objective gradings, greenwashing and consumer choice | FCA Insight.