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(mis)Conduct, Money & Reputation
A series by reputation specialist Lansons Team Farner and law firm Katten. Join asset management experts David Masters (Lansons), Neil Robson (Katten) and guests as they dissect the top stories and misconduct cases across the industry, impacting reputation, brand trust and integrity.
(mis)Conduct, Money & Reputation
DWS, Sustainability & Disclosure
ESG, and specifically sustainability, is an increasingly controversial topic for investment managers, with diverging regulation in Europe, the US and UK, and rising numbers of reputational hazards to navigate. Many fund companies are removing phrases like “ESG” and “sustainable” from product names, whilst downgrading the obligations that these funds have to the principles of ESG. At the same time, it seems that many investment businesses have been overstating their sustainability credentials, and at least two firms have been fined over $25 million in recent years for making false claims.
In this episode, we explore the increasingly widespread issue of misconduct surrounding ESG. From the companies that have fallen foul of the regulations and the regulatory trends, to the challenging act of maintaining a good reputation in an environment where ESG appears to have as many detractors as it has advocates.
Disclaimer:
The content in this podcast is for informational purposes only. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest standards of care applicable to attorneys in any given situation. This podcast is considered attorney advertising. Prior results do not guarantee a similar outcome. Any views, opinions or comments made by external guest speakers - are not to be attributed to Katten Muchin Rosenman LLP and/or Katten Muchin Rosenman UK LLP or their individual attorneys/lawyers. All rights reserved.
Recorded and produced at the Lansons Studios
This is Misconduct Money and Reputation. A podcast by reputation specialists Lansons and law firm Katten.
Speaker 2:Hello and welcome to the episode. This is our second episode in a new series for those working in financial services, particularly in and around asset and wealth management, where we seek to navigate a path through some of the more complex issues where regulation and reputation intersect. Esg, once a potential saviour, seems to be an area dense with both regulatory and reputational hazard. My name is David Masters, Director and Asset Management Lead at Reputation Consultancy Lansons team Farner.
Speaker 3:And I'm Neil Robson Financial Services, Regulatory Compliance Partner at International Law Firm Katten.
Speaker 4:And I'm Sam Sharpe, Director and Sustainability Lead at Lansons team Farner.
Speaker 2:So to get us started, I just want to set the scene a little bit. Esg is a vast topic and it's very unlikely that we're going to be able to cover everything that we could possibly do in the space of 25 minutes. I also think that it's important that we start with a bit of a historical top-down perspective on ESG and its place in the investment industry, because it has always been a little bit controversial. There's always just been that little bit of tension between the needs of the ESG investor and the needs of the asset manager. Without getting too much into the weeds, the original ESG portfolios largely tended to be exclusion based, ie avoiding sin stocks, for example, so firms operating in the gambling or alcohol or tobacco sectors, primarily.
Speaker 2:So the time that ESG was beginning to gain a little bit of momentum in the late 90s and the early 2000s is a time actually when a lot of these sin stocks were performing quite well. So very early on it became the mantra that by investing in ethical or sustainability or SRITAC portfolios, you are going to be giving up on financial returns. This raises the other factor Funds are sold, not bought. Although big-ticket institutional investors obviously have substantial buying power and influence, the reality is that investment products are primarily sold, usually by some form of financial intermediary, to a buyer, and this ultimately has shifted behavior away from the adoption of responsible investing principles because of this idea that when you invest in ESG you're giving up returns. And it's really only in the last few years, and boosted by regulatory and legislative shifts, that ESG has approached any form of critical mass and in fact we now see it growing quite rapidly.
Speaker 2:Now I think we have to be fair to the asset management industry, because not everyone has felt that way. There are a number of managers over the years who did and still do believe that by investing along sustainable principles that you can outperform. I suppose in the UK the best known of these is probably Hermes, now federated Hermes, which was originally spun out of the BT pension scheme in the 90s and was in the early days, was led by Alistair Ross Gooby, who was a major influence in UK governance principles, and it's now led by Sakina Sabi CBE, who again is very much one of the proponents of ESG investing on an alpha basis. So we can see that this has evolved quite dramatically over the last few years and obviously it's regulatory developments which have been at the driving edge of this. So, Neil, given that we now have sort of three key regulators operating so we have the UK, we have the EU and the US what are the sort of current regulatory developments that we really need to be aware of?
Speaker 3:Well, it's an interesting one because actually across the EU, the UK and the US, the principal driver of legislative provisions that asset managers and others are required by law to follow has actually been the European Commission. The EU has been the driving force behind the majority of sustainability and ESG related legislation. But that's just part of a mosaic or a framework that we see on an international basis. So if you think about the three pillars of ESG E, environmental we've got a lot of sustainability reporting requirements. So, for example, in the UK there's the task force for climate related financial disclosures, tcfd that listed companies and FCA regulated firms are going to have to comply with over the coming next year two years as a result of that TCFD set of requirements being baked into the FCA's new ESG handbook. Interestingly, at the moment, as it stands, the ESG handbook only relates to the TCFD, the sustainability disclosures.
Speaker 3:In the EU things are very different. There's a broad range of disclosures. Under the taxonomy regulation, the financial reporting requirements related to financial services firms are very broad in scope. If you're marketing a fund in the EU, you're going to have to make all sorts of additional disclosures disclose whether you're an article eight or an article nine fund, which basically means are you light green? So you take sustainability into account? Are you dark green, where it's actually a driver for your investment strategy?
Speaker 3:We've also got the social pillar, the S, which is about human rights and equality and diversity and so on.
Speaker 3:That, of course, will also bring into account the relationships as to how an organization works with regard to its people and the people in its supply chains.
Speaker 3:So, device diversity and equity yes, that's a given, but of course, we've also got something there to think about that labor practices and the wider supply chain.
Speaker 3:If you're someone who's working elsewhere in the world, for example, the UK Modern Slavery Act requires that you know who you're dealing with in all those different countries. So we've got a huge range of legislation that, if you say your ESG compliant or you take ESG into account in your investment strategies, that's a vast range of legislation you have to think about and, of course, the big one that we're going to focus on in a little bit is that, actually, if you claim you have ESG as part of your investment strategy, if you claim you have sustainability at the core of your practices, if you put that in a prospectus, if you put that in an offering document, both in the US, as we've seen most recently with an SEC enforcement action, but also here in Europe. If you say you're doing something and it's not true, you're liable to a fraud investigation or worse. That's a pretty big deal because you've effectively lied in a public document.
Speaker 4:And to pick up on your point there about you know you can get in trouble for putting something in a public document that isn't true. I think what's interesting is how we've seen different bodies slap wrists over the recent year of not only companies putting things that aren't true but actually emitting things or not giving audiences or consumers the full picture.
Speaker 3:And if you are telling the public something, if you're using this as a marketing tool, you need to be quite clean and very open about what your position is. Now in the financial services sector, there's actually a requirement that's been in FSA rules as long as I've been around, obviously now in FCA rules and given the MIFID 2 rules across the whole of Europe. This piece of it was put into MIFID 2 by the UK before Brexit, but that's that if you are advertising a financial product or a financial service, you have to be both fair, clear and not misleading. That's the absolute standard across the UK and the EU. So I think that realistically, that's a very, very hard target or standard to meet, but that is ultimately the requirement. Yeah, I completely agree.
Speaker 4:And when you're talking about what is effectively a two meter by one meter piece of paper where they're expected to get across the complexity of effectively, a transition economy. It is a tough ass, but I think that that open honesty is interesting because it's what needed, it's what the regulators are pushing for, but I think it's a very it's a very difficult and vulnerable position for organisations to put themselves in.
Speaker 3:And it does beg the question whether we lawyers, unfortunately, are going to end up meaning that there's pages of disclaimers at the bottom of those posters, which might be the only way around it.
Speaker 2:I was going to bring in the investor at this point, because I think the challenge here is also for the investor is understanding what the product they're investing in is doing, and I think this has very much been the FCA's line of attack, isn't it? You know, do investors understand what your fund is doing? Is your fund doing what it says it's doing, and can investors tell whether your fund is doing what it's doing? So where does this leave them? I think it's the question I had.
Speaker 3:Well, I think that the fair, clear and not misleading requirement. It's a slightly sliding scale in the sense that if you're an institutional only manager so your fund can only take professional investors and eligible counterparties, not retail then actually I think that you should be taking a view that your investors have a higher level of understanding. But if you're focused on retail, then you have to be absolutely clear and not misleading, as well as fair, of course, but nonetheless that's a slightly different standard. So it's much, much more difficult, I think, for a retail focused firm.
Speaker 2:So there are a number of companies which have been fined or challenged over the last few years. I mean, one of the most recent ones, I think, was DWS. Neil, can you just give us a bit of detail about really what happened there and what the sort of consequences are?
Speaker 3:Yeah, I mean that one's been absolutely fascinating to follow because it stemmed from a whistleblowing disclosure from the inside of DWS. So DWS was the Investment Arm of Deutsche Bank. Ultimately, it was investigated by both the US and German financial regulatory authorities because of whistleblowing disclosures from Desiree Fixler. So Ms Fixler was the former head of sustainability at DWS and she did a whistleblowing because she was very, very concerned that DWS had made misleading claims in its 2020 annual report that basically, the claims made were that more than a half of the group's $900 billion in AUM were invested following ESG criteria. So Ms Fixler claimed that actually that was not factually correct. She blew the whistle to the German regulator, barfin, and then Barfin did their investigation, which led to raids on both DWS itself and also on its parent at Deutsche Bank. Ultimately, it led to the resignation of Ashoka Werman, who was the chief executive of DWS. He resigned in June last year.
Speaker 3:The public prosecutor's office in Germany then said, interestingly, that again I'll read a quote here sufficient factual evidence emerged that, contrary to the statements made in the sales prospectuses of DWS funds, esg factors were not taken into account at all in a large number of investments. So that's quite interesting. So what ultimately then happened is Barfin, the German regulator, had an enforcement action against DWS. They alleged prospectus fraud because the statements made were false, misleading and were not factually correct In the states, because DWS is active there, also marketing various funds.
Speaker 3:The SEC, the Securities and Exchange Commission, investigated and they came to a broadly similar position, that being that DWS was making materially misleading statements about controls over ESG factors. So that was quite fascinating. It was just last month September 2023, that, in fact, dws settled with the SEC and agreed to pay $19 million to settle the charges the SEC had brought for materially misleading statements effectively prospectus fraud, which was the highest fee, or fine, rather, ever charged relating to environmental social governance factors against an investment advisor in the USA. Now what's fascinating here is that, as whistleblower, ms Fixler was fired by DWS. She was interviewed recently and she said that she didn't regret anything about this whistleblowing because, as an ESG specialist, a sustainability boss of DWS, she said that she was. Ultimately, it was an important factor for her to make sure that this became public.
Speaker 2:And again, it's a point we picked up in our previous podcast about the treatment of whistleblowers, but that's probably a separate podcast in its own right. Indeed, I think there are a couple of things here and I think it's really interesting because obviously I think what we're now beginning to get the sense of is that, whilst all this has been going on and we think of what's going on in the US in particular ESG funds have been witnessing inflows and inflows and inflows, certainly outperforming other active managed funds and often at times outperforming in terms of inflows and passive funds as well. But just very recently, we've started to see that drop away, not outflows, but the rate of growth has slowed, and some of that, I think, is down to greenwashing. I think the AIC put out something very recently which was some research, saying that investors were beginning to get wary about greenwashing. But this is a really difficult situation for investors because obviously the will is there, the desire is there for their capital to be put to good use, but clearly the more of these greenwashing scandals are that it's the classic reputation management thing the worse your reputation is, the less people will do business with you, and the challenges for DWS and for those other firms who've come unstuck along the way are getting people to reengage with them.
Speaker 2:But I think now we see that and it's probably not just a reputational issue. I think we can look at the current state of the economy current persistent high inflation, high interest rates, meaning that cash is a much more attractive investment for a lot of people. But just to turn to you then, sam. So we talked about greenwashing as an issue, but there are some other phrases out there which seem to be doing the rounds at the moment, which seem to be almost the antithesis of greenwashing. So what do things like greenwashing mean and who's doing them?
Speaker 4:Yeah. So I think, just to context some of those other phrases doing the rounds and to pick up on what both of you just said, I think part of that negativity and debate and firms getting into trouble is partly stems from the fact that there is no universal agreement really over what this thing means and to some it's risk mitigation, to some it's getting some form of utopias. The debate and controversy around this, I think, is also a sign that it's fully arrived and it is huge and knotty and the biggest challenge we have ever faced. So we're not going to get it right and not every firm is going to get it right. And I think when you look at greenwashing and now all the nuanced forms in which it's taking, so greenwashing is where firms effectively clam up and hold back and they might be doing great things behind the scenes but they're not talking publicly about it.
Speaker 4:To take another one, such as green shifting so particularly relevant when you're talking about manufacturing firms, firms with supply chains, when you, if you're making a product and instead of focusing on the carbon footprint around how you manufacture and move, source the ingredients for that product, you put the emphasis on talking about how an end user uses that. So if it's soap, for example, rather than talking about how you're making that soap, it's well you know, people should have showers rather than baths, and they should limit how much hot water they use. It's. A lot of these things can be done unconsciously, which I think is where it really begins to feel like a minefield for lots of firms and there's so many pitfalls to fall into. But I think it comes back to just remembering that this is really hard, and I think often comms end up on the front line on this.
Speaker 3:I think, one really interesting sort of case or scenario we perhaps talk about in that exact context. It's hard, you know firms can be trying to do the right thing and yet you've still got the risk of trial by media. So this summer, bailey Gifford, big UK asset management firm, who were the sponsors of the Edinburgh International Book Festival I don't know if you saw that that one of the key speakers was due to be. In fact, the key speaker was due to be Greta Thunberg, who I understand was gonna get a boat across to Scotland so that she didn't have to use too many CO2 emissions to get there, but she pulled out when an investigation went public.
Speaker 3:A freelance journalist publicized the fact that Bailey Gifford doesn't have an entirely green, co2 free investment portfolio and the numbers here were fascinating because Bailey Gifford actually, I think, in the big picture, isn't doing too badly compared to many others. They're pretty good. So the numbers that were published which led Greta Thunberg to pull out, were that actually 2% of Bailey Gifford's investment portfolio companies that's 2% of 223 billion AUM were in companies that get 5% or more of their revenue for oil and gas related activities. Now part of that includes, for example, tesco, because Tesco has obviously a petrol business, so she pulled out.
Speaker 3:There was a lot of very bad PR, unfortunately for Bailey Gifford at that point in time the fact that they invest vast majority of their 223 billion AUM in non-CO2 producing businesses and investments. They still got knocked around it by the media as a result of this. So it's unfortunate, it's very hard and you kind of lead to the question that do you have to invest in nothing that produces CO2 in order to be held up as the poster chart of ESG and avoid any risk of greenwashing? That's that's going to be pretty hard if you're a broad-based investor.
Speaker 2:Well, I think it is really hard, and I think this sort of plays into another quite substantial issue, which is, if you look at this from the perspective of the investor. You know, not all investors' values are the same, indeed, but there is no archetypal ESG philosophy as far as investors are concerned. There might be in terms of how asset managers present what they do. We've moved now much more to what's called ESG integration, but ESG integration has comes with its own challenges, because it's very much, if you like, it's because of this idea that funds are sold, not bought. You know it's the build it and they will come mentality.
Speaker 2:So I think a lot of the issues we're seeing in with with ESG today in particular, is that there is a conflict sometimes between what the asset managers can do and are doing and what investors want. So, if you like this, we'll call it ESG plurality, where an investment manager might offer some funds which have an ESG focus and some funds that have ESG which have an ESG focus and some which don't. But ultimately, more and more investors are taking the view well, if that investment manager is investing in fossil fuels outside of my portfolios, I don't want anything to do with them, and I think that is going to be a considerable challenge, as an ESG investment involves and moves towards probably more along the lines of impact investing.
Speaker 4:I think that's a really interesting point, the balance point. And if you, if you start to see investors have some ESG fund at some non, because I think the word that sometimes get lost in this whole discussion is transition, and it goes back to the Bailey Gifford point is that whatever you consider good or not quite good enough, that the aim is to effectively rewire our entire economies to one that is more sustainable for us to continue the type of life we as a whole want to live. If you start to lose what that sense of overall balance and transition is, it becomes to get it comes, it starts to get really quite difficult.
Speaker 3:We have a true minefield ahead of us here that if you're trying to disclose to investors how sustainable you are, how truly green your fund is, you've got a whole raft of things you're going to have to try and juggle at the same time in order to satisfy investors in different jurisdictions. So ultimately, I think we're looking at a traditional fund prospectus with different wrappers for different countries, making all sorts of additional disclosures. So, as keen as an manager is to present itself as sustainable to meet those requirements, that okay, this is our version of ESG you have to disclose, disclose, disclose. You're going to have to make everything crystal clear to avoid the risk of greenwashing, to avoid the risk of prospectus fraud or misleading statements. So I think, in some ways, all of this is making asset managers' jobs a thousand times more difficult.
Speaker 2:And that disclosure, that transparency, is really important, because all the evidence about you know, if you think of index investing and everything like that is that the more the end investor understands what they can do, what their money can do and the power of their money, then the more demanding they become as investors. And we've seen that with the sort of you know the way that fees and charges have declined over the years and ultimately the fiduciaries become aligned to that thinking as well, which is why these sort of trends around hyper personalization are important.
Speaker 4:I think there is an interesting dilemma there about the what firms are doing at fund level and actual products and what they're offering to investors, and then what they say they stand for as an overarching organization and a firm and I think those two.
Speaker 4:Quite often there is a bit of a disconnect and that's where they can get into a little bit of hot water as well, and there is a need for clarity and honest discussion internally.
Speaker 4:So what you are trying to achieve and to have you know, as you put it, the bricks so that investors can build exactly what they want. But you still need that piece as to what you stand for as an organization and what you believe in. On this, I think it's something that, in particular, lombard ODA have done very well for a long time is that, as they transitioned what they were looking at from a fund and a product perspective and how they were working with clients and investors, they did really nail, in my opinion, that overarching piece where by they said they came up with this there's an acronym, clic, whereby everything we invest in is looking to be clean, lean, inclusive and circular, and those are the overarching principles by which we will run the organization, invest money and that's the world we're trying to build and I thought that's getting those two things right. I think is hard but really important.
Speaker 2:Yeah, no, I think that's a really good point, and it is again. It comes back to this sort of idea of purpose. So we have the purpose of the investor, but we also have the purpose of the asset manager, because the asset manager ultimately is the conduit through which that investors money gets into the market, and I think those are really, really important principles.
Speaker 3:We've seen quite a few fund managers have their sort of environmental mission statement. You know it's on their website, it's public. All their portfolio managers are required to adhere to it If they are going to make an investment that's off-piste. It needs to be a damn good investment, otherwise you're breaking your own mission to the public Again. That then goes to have you engaged in false advertising effectively. So I think that where you do get managers who are prepared to jump feet first and say this is what we stand for, that's got to be a fantastic step forward.
Speaker 2:Great. So that's all we have time for today. We'll be back next month where we'll be exploring further areas where reputation and regulation intersect in the world of asset and wealth management. Do check the show notes for links to some of the things we've been talking about today and if you have questions or suggestions for future topics, then do get in touch at studios at lansonscom.
Speaker 1:You've been listening to misconduct, money and reputation. Please do stay tuned for further episodes by subscribing on your favorite podcast app. You can find us by searching Lansons or Catten. This episode was recorded in the Lansons studios and brought to you by reputation specialists Lansons and Lawfone Catten. The content in this podcast is for informational purposes only. It does not constitute legal advice and does not intend to establish an attorney-client relationship, nor is it intended to suggest standards of care applicable to attorneys in any given situation. This podcast is considered attorney advertising. Prior results do not guarantee a similar outcome. Any views, opinions or comments made by external guest speakers are not to be attributed to Catten Mutian-Rosemann LLP and or Catten Mutian-Rosemann UK LLP or their individual attorneys lawyers. All rights reserved.