In 2018, the Global Sustainable Investment Alliance (GSIA) identified that nearly $31 trillion is managed under responsible investment strategies globally. Canada is not immune from this trend: the Canadian Responsible Investment Trends Report found that as of 2018, more than $2 trillion in Canadian assets were managed according to one or more responsible investment strategies.

Much of this growth has been centred on ESG funds. According to Morningstar data, their value now surpasses $1 trillion USD globally. However, this phenomenal growth is beginning to reveal fault lines that have the potential to undermine the legitimacy of the ESG fund sector, especially if there is no improvement made to oversight or regulation.

For the ESG fund market to retain the confidence of investors, ESG funds must not only deliver returns, but must also generate the impacts in the real economy which they claim (i.e., lowering carbon). This is particularly important for climate-themed funds, which have been identified as a key instrument in driving climate finance and shifting investment from brown to green assets.

However, in the absence of any meaningful regulation to define green investment, prospective investors in climate-themed funds face a dizzying array of terminology — carbon constrained, carbon momentum, carbon neutral, climate aware, climate strategy, fossil fuel reserves free to name a few — with little indication of how these terms relate to the contents of the fund itself.

In light of this, InfluenceMap, a U.K. based think tank, analysed 118 ETFs marketed under a climate theme with an aggregate AUM of US$18 billion, four of which are sold to retail investors in Canada.

Surprisingly, the 118 funds analyzed had an aggregate exposure to thermal coal reserves roughly equivalent to that of the iShares MSCI World ETF. In other words, these funds, despite their climate positive marketing, ended up with an exposure to thermal coal reserves comparable to that of a mainstream global large cap benchmark.

In total, 22 funds were found to have exposure to thermal coal or oil and natural gas reserves. At the extreme end, two funds from Asia-based Fullgoal and Lion Asset Management companies were found to have thermal coal intensities (defined as tons per $million AUM) 50 times greater than the MSCI World ETF because of their large stakes in major Chinese coal producers. A range of other funds also contained major fossil fuel producing companies which investors would no doubt be surprised to find in a purportedly green fund: BlackRock’s iShares MSCI ACWI Low Carbon Target ETF, for example, holds shares in oil majors Chevron and Shell.

Notably, all four funds available to Canadian retail investors, with an aggregate AUM of $186 million, were found to have zero exposure to fossil fuel reserves. The funds, whose managers include RBC and BMO, are detailed in the table below.

Admittedly, there is currently no legal restriction to prevent a low carbon fund from investing in fossil fuel companies which means the funds analyzed are not necessarily in violation of their stated remits.  However, the findings speak to a broader issue regarding the lack of clarity for retail investors in this burgeoning sector.

BlackRock, in response to InfluenceMap’s findings, simply stated: “The fund is named low carbon to ensure investors understand the ETF is seeking lower carbon exposure, but it is not a no carbon fund.” While true, there is no guarantee that retail investors understand these labels in this way. Clear evidence that the labels are not used uniformly across the market is muddying the waters for climate concerned investors.

Moreover, while a low carbon label may not preclude a fund from investing in fossil fuel producers, it is reasonable for investors to expect that a fund labelled ‘Fossil Fuel Reserves Free’ would, indeed, be free of fossil fuel reserves.

Yet InfluenceMap’s research uncovered two State Street funds marketed as fossil fuel reserves free. The funds are worth a combined $100 million, with significant exposure to fossil fuel reserves through holdings in companies including German power company RWE and Brazilian mining giant Vale. It seems more than reasonable to assume that a typical retail client interested in investing in a climate sensitive manner would not expect to hold shares in a company like RWE, a major coal power generator and operator of the highly controversial Hambach lignite mine in Germany.

In response to InfluenceMap’s research, State Street argued the report had missed “important nuances,” particularly around the term “fossil fuel reserves” which, in their estimation, refers only to oil and gas and not to thermal coal. The clarification of this nuance is unlikely to placate retail investors who likely recognize thermal coal as the most CO₂ intensive fossil fuel.

Importantly, these issues are echoed by broader concerns surrounding impact washing, whereby a financial product is marketed as generating a positive impact environmentally, socially or otherwise, without any rigorous substantiation of this impact. Recent research from 2 Degrees Investing Initiative found that 85% of ESG-themed funds in their sample made unsubstantiated or misleading claims in violation of existing market regulation. These findings underscore the need for a clear, consistent and robust method of not only categorizing green or impact funds but also of measuring and verifying their effects on the real economy.

The European Commission is leading the way in attempting to remedy these challenges. It’s currently developing a suite of policy measures designed to regulate the industry including two new climate benchmarks against which climate-focused indices will be required to gauge their performance. The EU is also pursuing a Taxonomy for Sustainable Activities which will define what constitutes sustainable or green economic activity. However, despite the promise of these changes, progress remains slow. Last week EU governments agreed to delay the release of the Taxonomy until 2022 following some controversy over the potential inclusion of nuclear and coal-fired power plants.

Nevertheless, the Commission’s work represents a first step in the crucial process of generating improved oversight of this sector. Canadian regulators should take heed and refocus efforts on establishing mechanisms to ensure ESG funds are marketed according to a rigorous system in order to ensure this growing sector not only meets investors’ expectations, but also delivers the changes in the real economy that it promises.

Adrienne Buller is a research policy analyst with InfluenceMap.

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Nearly all of us consider ourselves to be ethical people, but few of us like paying taxes because it requires us to part with our own money. Rather than resolve the tension between affirming our own ethicality and loss aversion, we resist seeing taxes as an issue of ethics or sustainability.

The problem isn’t just a personal one, it’s permeated corporate culture around the globe. According to a report released last month by the Canadian Parliamentary Budget Office, Canadian corporations likely avoided $25 billion in taxes in 2016 (in line with previous Corporate Knights/Toronto Star analysis which found $62.9 billion in corporate avoidance over six years). In the U.S., 60 profitable Fortune 500 companies (including Amazon,Chevron, General Motors, Delta, Halliburton, and IBM) earned over US$79 billion collectively in 2018 and yet they paid $0 in taxes. Many received tax refunds.

Robert Bird, a University of Connecticut business law professor, and I argue in the Journal of Business Ethics that the problem of tax avoidance is similar to that of overfishing, air pollution, and other so-called “collective action problems.” These are problems for which everyone is better off by cooperating in the solution. If increasingly more of us avoid taxes, the impact will compound to impair the health, safety, and productivity of a nation. Obviously, tax avoidance diminishes the total resources available in public coffers to fund critically important education, infrastructure, and even defense spending.

It also inflicts harm on the regulatory system and all those who participate in it, including you, me, and our employers. Tax regulators and legislators have to expend more resources to police compliance and shore up textual weaknesses in the law, making compliance more challenging and costly for all of us.

Healthy firm culture is built through ethical leadership and trust. Tax avoidance necessarily requires hiding or clouding information from regulators, stakeholders, and the public. That kind of conduct indicates to others that hiding information or engaging in self-interested behavior is permissible. This signaling can erode a firm’s ethical culture and governance.

How do we fix this? We can begin by adding taxes to the long list of important sustainability issues. This doesn’t mean asking whether the firm can get tax credits for adding solar panels.  Rather, it means asking if you or your firm are fairly and adequately contributing taxes in the communities affected by your operations, products, services, and employees.

For many firms, a starting point could be including tax analysis in sustainability reporting for the Global Reporting Initiative or the Dow Jones Sustainability Index. For firms that already include taxes in sustainability reporting, most report only superficial or aggregated numbers that obscure the answers to whether a firm is contributing appropriate amounts, for appropriate activities, at appropriate times, to the appropriate sovereign. It’s these questions that should drive a sustainable tax policy.

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Author note: In addition to the article in the Journal of Business Ethics, a research brief is available for sustainability practitioners in a new series published by the Ray C. Anderson Center for Sustainable Business at Georgia Tech’s Scheller College of Business.

Karie Davis-Nozemack is an associate professor of business law and ethics at Georgia Tech’s Scheller College of Business and a faculty affiliate of the Ray C. Anderson Center for Sustainable Business. Her research examines legal and ethical mechanisms for constraining opportunistic managerial behavior, including tax whistleblowers, tax compliance strategies, and fiduciary duty.

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