‘Worse than PPI’: green funds may be the next mis-selling scandal

Investment firms are overstating their ethical credentials, writes Sam Benstead

The next financial mis- selling scandal is already brewing and compensation claims could exceed both payment protection insurance and pension transfer misselling combined, according to investment experts.

More than half the money invested in Europe last year went into “sustainable” funds, taking the total to £1 trillion, according to the Association of the Luxembourg Fund Industry. Fund groups have raced to promote strategies that incorporate environmental, social and governance considerations.

But investors could be being misled, with investment firms exaggerating their green credentials on glossy marketing materials to attract cash.

Capco, a consultancy, said investment firms’ rebranding of funds to cash in on the ESG “gold rush” meant that many portfolios were not doing what they said on the tin. It said that self- proclaimed “green” strategies were still owning sin stocks, such as tobacco and oil.

Capco’s Charles Sincock said companies were desperate to prove their environmental credentials and warned that the potential risk of misselling could not be understated.

Whistleblowers at DWS Group, an investment manager that was spun out of Deutsche Bank, and BlackRock have raised the alarm already.

Tariq Fancy, BlackRock’s former global chief investment officer for sustainable investing, said ethical investing was “dangerous” and bad for the public, and that fund managers wanted to merely “pass the ESG test”.

Desiree Fixler, DWS’s former head of sustainability, told The Wall Street Journal that the firm painted a “rosierthan-reality” picture of its sustainability efforts to investors and struggled to implement its ESG strategy.

The American financial regulator has begun an investigation into DWS for allegedly overstating its ESG credentials across a $1 trillion fund range. A spokesman for DWS said the firm did not comment on regulatory matters but added: “We firmly reject the allegations being made by a former employee.”

The Financial Conduct Authority, the City watchdog, is readying itself to fight similar battles on behalf of regular investors.

The FCA has warned fund groups that they must improve how they market their funds as it is aware of a rise in companies branding strategies as sustainable without substantiating their claims.

These included “ESG” funds that tracked indices that were not sustainable and funds that claimed to be sustainable but had fossil fuel companies among their top 10 positions.

“We expect clear and accurate ongoing disclosures to consumers where funds make ESG-related claims, and we want to see funds deliver on their stated objectives and/or strategy,” it said.

Jonathan Cavill, of the law firm Pinsent Masons, said “greenwashing”, where a firm exaggerates its green credentials, was bound to give rise to increasing regulatory scrutiny and consumer claims, whether by litigation or via the Financial Ombudsman Service, with the FCA playing a key role in determining whether a fund has been missold. He said that total claims could top those of PPI and defined benefit pension transfer mis-selling scandals given the amount of money that had gone into ethical strategies.

“There could be a range of mis-selling type complaints and claims emerging in which consumers raise points related to greenwashing. For example, that the investment fund’s ESG rating was not properly explained to them, or that they were misled about what investments a fund actually holds, especially ones that have a negative ethical impact,” he said.

Mr Cavill added that the FCA’s framework for assessing greenwashing, when implemented, would provide ammunition for consumers against fund management groups.

“Where a firm publishes a misleading rating across a large swathe of promotional material, it could be faced with a serious systemic issue where it may be obliged to compensate a large cohort of consumers, or face FCA enforcement and ombudsman intervention,” he said.

Compensation for consumers that have been misled could take a variety of forms. Mr Cavill said a payout could be quantified by comparing the performance of a mis-sold investment with a green fund that would have better met someone’s ethical investing needs.

“The challenge here may be that customers may actually have made more money from the investment which they were mis-sold, compared with the fund which may have been a better fit,” he said.

If there was not a financial loss then investors can still argue for compensation, Mr Cavill noted.

“Some customers may ask for ‘distress and inconvenience’ or ‘pain, suffering and loss of amenity’ payments, but they can be challenging to quantify and to prove,” he said.

The ombudsman has four bands for non- financial claims, ranging from less than £500 for moderate issues to

more than £5,000 for extreme issues. It said it might ask for supporting information, such as how something had had a significant impact on health.

Although it has not dealt with greenwashing claims to date, the ombudsman said that it would establish a framework for dealing with such claims when they arrived.

“As consumers start to bring complaints about ethical investments to our service, we’ll investigate what’s happened and, if needed, we have the power to make the business put things right,” a spokesman said.

An ethical funds mis-selling scandal could even destabilise the financial system, added Mr Cavill, if fund groups and insurance firms were hit with a large number of compensation claims.

“A real concern for government, policymakers and regulators would be the financial stability implications. Obviously the financial crisis is not that far behind us, and with market strain events such as Brexit and Covid-19, a subsequent greenwashing scandal could further shake market stability,” he said.

Investors can take steps to protect themselves from greenwashing. Hortense Bioy, of the investment data group Morningstar, said investors had to look under the bonnet of a fund to see where it was really invested.

‘Payouts could be linked to investment losses or emotional pain from owning sin stocks’