Over the past few years, discussions in the conference rooms of major asset managers—the kind with floor-to-ceiling windows overlooking financial districts in New York, Frankfurt, and Sydney—have resulted in marketing language that regulators are now parsing with a precision those rooms probably didn’t anticipate. “Part of our DNA.” “A leader in sustainable investing.” “ESG-integrated across all asset classes.”
Throughout the late 2010s and early 2020s, ESG-labeled funds garnered significant capital inflows. The words were intended to appeal to a growing generation of investors who wanted their money aligned with values as well as results, and they worked. It turns out that many of those funds lacked a formal policy outlining the precise application of those principles to individual stocks. This omission is now a costly issue.
Penalties against some of the most well-known names in asset management are part of the greenwashing settlement wave. Invesco paid the SEC $17.5 million for failing to implement formal policies that would define and categorize what “ESG-integrated” actually meant for its portfolios. In other words, the company made claims about how much of its assets incorporated ESG factors without having a documented framework that would allow those claims to be verified. DWS paid €25 million in Germany and $19 million to U.S. regulators for misrepresenting its ESG investment procedures and not adhering to the screening criteria it had promised clients.
Regulators discovered that WisdomTree’s ESG-labeled ETFs were actually holding companies in the tobacco and fossil fuel industries, which the fund’s marketing materials specifically stated it would not include. As a result, WisdomTree settled for $4 million. Additionally, Vanguard Investments paid a record A$12.9 million in Australia after a Federal Court determined that, despite the funds’ sustainability branding, roughly half of the securities in its global bond index funds had undergone no ESG screening at all.
Malicious fraud in the conventional sense is not what unites these stories; none of these businesses were falsifying holdings or performance metrics. The issue is more subtle and, in a sense, more intriguing structurally: the industry created a product category based on language that was never precise enough to mean anything specific, and then charged customers—often at a premium price—for a service that was too vague to be verified.
An ESG fund is labeled as “ESG” based on its marketing. According to the brochure, the screen is rigorous. Many companies found they lacked the written rules that would support their statements when authorities requested them. These settlements are filling that void.
Because it impacts the largest group of retail ESG investors, the passive fund issue merits special attention. A number of prominent managers had been labeling all of their passive index products as “ESG integrated by default” on the grounds that interacting with firms on governance concerns and acting as a responsible steward of capital were enough to qualify for the designation.
Regulators have categorically rejected that framing. An index fund cannot claim ESG integration if it isn’t tracking an index that uses particular ESG inclusion or exclusion criteria. The label must explain the real function of the securities selection process rather than the aspirational culture of the asset management company.
The industry’s response has been costly and continuous. Businesses are revising prospectus wording with the kind of specificity that can withstand regulatory scrutiny, recruiting specialized ESG compliance officers, and developing data infrastructure that can track and record screening choices at the individual security level. In order to remove ESG labels that are no longer supported, certain funds have undergone restructuring or renaming. In fund databases, others are discreetly reclassified.
Over time, it’s still unclear if any of this results in a more really sustainable investing sector or if it just leads to better-documented assertions about the same underlying behaviors. However, the cost of ambiguity has been apparent due to the fines, and this has altered the writing of the following set of product descriptions.
