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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To add some personal flavour to the divestment issue, we asked one of the architects of the movement – climate activist, author and 350.org co-founder, Bill McKibben – to chat with us about how he invests his own money for our inaugural Money Talks column.

What sparked your initial idea of asking institutions to drop their investments in fossil fuels?

Naomi Klein and I were reading the same somewhat obscure report from a London-based think tank, Carbon Tracker Initiative. It showed that these companies had far, far more carbon in their reserves than any scientist thought we could ever burn. Both of us thought: viewed this way these are rogue companies, trying to profit off unfathomable destruction. Since we’d both been active in the anti-apartheid divestment movement a generation earlier, we figured maybe it might be appropriate here.

Who was the first person you were able to convince to divest?

Pride of place goes to tiny Unity College in rural Maine. The president got up during one of the roadshows of the Do The Math tour to make his announcement  – an $8 million endowment, I think. Now that we’re at $8 trillion it doesn’t seem so big, but it got us going.

What’s been your biggest win so far?

The Norwegian sovereign wealth fund? The nation of Ireland? New York City’s pension fund? Half the universities in the UK? The first win that really started to change things fast was perhaps the Rockefeller family, who divested their charities. If the original oil fortune was done with oil…

Why do you think there are so few Canadian organizations on board with divestment?

Because Canadians, pleasant and conflict-averse, can’t bring themselves to say to Alberta, ‘you simply can’t dig up all that oil and burn it, it by itself will use up a third of the planet’s carbon budget.’  So they’ve never been able to really grapple with climate change. Look at the tragic positions that Justin Trudeau has gotten in trying.

The Canadian responsible investing sector has focused more on shareholder engagement to push for change from the inside. What are your thoughts on this tactic?

Works with many kinds of companies, but not fossil fuel ones. Because there’s not a small flaw in the business model–the flaw is the business model.

Petroleum producers have, not surprisingly, tried to discredit the divestment movement. What’s the biggest myth being propagated about divestment?

That it doesn’t accomplish anything. The industry has pushed it with great diligence (which should tell you something right there) but by now we’ve seen Shell having to declare it a material risk and Peabody Coal listing it as a factor in its bankruptcy. In Politico a few weeks ago, one coal exec after another explained they couldn’t raise capital anymore because there were too few funds left willing to invest

Your focus has been on convincing institutions to divest, but many individuals reading this will be thinking of doing the same. Do you think the ripple made by an individual’s decision to buy or sell a stock or fund makes any difference in the grand scheme of things?

Well, it’s more important to move institutionally, but to the extent that changing your light bulb matters, divestment would matter more.

Have you divested your personal investments to reflect your values?

I’m a…writer and volunteer organizer. What investments I have reflect my values.

Can you give us a rundown on which investments you hold?

Nothing that burns.

How has investing with your values worked out for you financially?

Living in the woods has worked out for me financially.

How has divesting worked out financially for those governments and institutions that have chosen this tactic?

Yes, anyone who divested has made out like bandits – the fossil fuel sector has badly underperformed the larger market. So, for instance, the New York State pension fund would have $19k more dollars per pensioner had it done the right thing when all this started.

What’s next for the divestment movement?

I think we’re aiming for $10 trillion by next year.

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