How companies relying on ESG ratings escalate the risk of unintentional greenwashing
Many organizations are relying on ready-made ESG scoring. However, ESG rating agencies have lately come under criticism for their lack of data accuracy – and relying on them can lead to unintentional greenwashing.
Greenwashing – a business's unsubstantiated or misleading claim about environmental performance – is a growing issue. Yet, it is seldom intentional. Over the past few years, more organizations are beginning to rely on external, ready-made ESG ratings provided by rating agencies to determine how sustainable a portfolio, investment, or supply chain is.
While it may seem like a “best-in-class strategy” (after all, the scoring is done by external, impartial agencies), solely relying on ready-made ESG scores can be problematic. Despite how good the metrics are, ESG scoring is usually based on secondary data – opening up the risk for investment managers or purchase managers to pick a dodgy green fund or companies on falsely-informed data. In a worst-case scenario, you unintentionally pass the incorrect claims about its ESG credentials forward to customers and other stakeholders.
When something seems too good to be true – it usually is. Sustainability analysis is a complex matter and simply relying on ESG ratings is often just that – too simple.
While there are no shortcuts around it, there are some concrete actions organizations can take to prevent unintentional greenwashing.
How to avoid unintentional Greenwashing
- Take ownership: source data (backed with evidence) straight from your suppliers or portfolio companies instead of relying on ready-made, often flawed ESG ratings;
- Back up your sustainability claims with accurate data: Never make claims regarding ESG credentials if you can’t support them with data;
- Be transparent with your findings: communicate and celebrate the wins, but be open to where more effort is needed.
What are ESG ratings?
An ESG rating is an analytical tool designed to score a company’s performance on environmental, social, and governance (ESG) topics in a standardized format. It aims to provide the necessary data to assess the ESG risks and opportunities of investments and understand a company’s or portfolio’s impact on the environment and society.
What is unintentional greenwashing?
Unintentional greenwashing takes place when an organization overstates or misleads its ESG efforts due to a lack of proper insights into its activities and control of the data used to back its ESG claims.
What are the pitfalls with ESG ratings?
Globally, policymakers and consumers are increasingly pressuring asset managers to disclose information on their funds and portfolio ESG impact. As a result, ESG rating agencies have become the talk of the market and grow in parallel with the trend of ESG investing. But recently, ready-made ESG ratings have been criticized for lacking transparency and control over the data used for the scoring analyzes.
While ready-made ESG ratings are a useful tool when they are data-backed and reliable, there are some noteworthy pitfalls posed by ESG ratings. For instance, most ESG scoring is often based on data collected from companies' annual reports, sustainability reports, policy documents, and other publicly available documents. Not only is there a risk that the data is outdated, but relying on the information the company has cherry-picked is rather one-dimensional and often doesn’t reflect the company’s true efforts and exposure to ESG risks.
Another main issue is that ESG rating providers also utilize estimated data from third-party sources to determine the scoring. For example, if a company hasn’t publicly reported its water usage, an ESG agency may instead use data from water utilities near the company’s operational sites to estimate its water usage at those locations. Even though it is a good method to provide a good estimation when information is missing – relying on estimations like this is a risky business. If it turns out that the estimations are wrong and the incorrect information has been passed forward to stakeholders and consumers – the reputational and financial backlashes could be severe.
Not long ago, the Swedish apparel-titan H&M was sued for breaching the “greenwashing law” for deceiving consumers through false and misleading data used for their sustainability claims. The company was using the popular Higg Materials Sustainability Index to score the environmental impact of the material used. According to the Norwegian Consumer Authority (NCA), which was the first to raise the concern, the index is misleading as the information supplied refers to an average environmental impact of a certain material, rather than accurate data on that specific product sold – meaning that H&M lacked true data to support their claims.
How to avoid unintended Greenwashing?
Organizations should actively collect, monitor, and track raw ESG data provided directly by their portfolio companies or suppliers instead of relying on unreliable ESG metrics. To prevent unintended greenwashing, you will have to put in the manual work and time to measure, understand and control the data you rely on and communicate to consumers and stakeholders.
Transparency is key, and if you can show how your data was sourced and analyzed, you can prevent unintentional greenwashing and possibly irreversible damage to your organization.
Manage your ESG data in Worldfavor
Collect, monitor, and track your portfolio companies' or suppliers’ ESG data in Worldfavor to get the proper insights you need to support your ESG disclosures. Our platform enables companies to get full control of data and take the ownership necessary to prevent unintended greenwashing. Sounds interesting? Let us tell us more on how your organization could benefit from Worldfavor!
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