Existing ESG labelling redundant amid investor confusion

Zenith’s head of responsible investment has suggested that ESG labelling on investment products is so unclear people are better off ignoring them, pointing to a desperate need for change.

On 18 July, the government opened a consultation and is seeking feedback on sustainable investment product labelling.

Put forward by Treasurer Jim Chalmers and Assistant Treasurer Daniel Mulino, the sustainable investment product labels paper covers policy options for a possible sustainable financial product labelling framework, the investment approaches that should be considered “sustainable” and the evidence required to substantiate a label, among other considerations.

The consultation has come on the back of mounting confusion about various sustainable, impact, ESG, green, ethical and responsible labelling products which has ultimately led to allegations of greenwashing and regulatory crackdown from ASIC.

Speaking with Money Management, Dugald Higgins, head of responsible investment and real assets at Zenith Investment Partners, suggested there is such a low level of consistency and clarity around responsible investment labels that they have become somewhat irrelevant.

“There is confusion about where the priority is. Is it the impact on financials or the impact on society? But it doesn’t stop there. When you also bring in ethical preferences, everyone has a different view on what’s acceptable, and how far in the value chain an activity occurs. 

“We suggest that advisers are sometimes better to ignore the labels, at least initially, and focus on what a fund is doing. Is it using ESG as a standard decision-making process, or is it going further by also looking at sustainability issues and real world outcomes to shape an investment’s objective?”

One of the key issues with the current labelling options is the lack of clarity and separation between the different labels used, such as ESG, sustainable, green, responsible and impact. While there are some links and commonalities between some of these, Higgins said, they are not interchangeable terms. 

“ESG is merely looking at the external E, S and G factors that influence an investment’s value via financial materiality (either as a risk or an opportunity). Sustainability is the opposite; it’s looking at how an investment impacts the world around it (impact materiality),” he said.

The primary difference here, Higgins said, is ESG considers the world’s impact on a company, while sustainability is a company’s impact on the world, meaning there are significantly different considerations to be made when investing.

“While sustainable funds consider ESG, not all ESG funds consider sustainability. ESG is just a process, not an objective.”

As environmental and social considerations become increasingly important among investors, ensuring there is clarity in the labelling of investment products becomes more crucial.

According to research from the Responsible Investment Association Australasia (RIAA) in 2024, 88 per cent of Australians said they expect their investments to be responsible and ethical, up from 83 per cent in 2022.

With the current lack of clarity, Higgins suggested that for now advisers and investors should “forget the label and look at what’s really happening”. Although this may solve short-term issues, the long-term challenges require change which is where the government consultation comes in.

Speaking on the announcement, Chalmers said: “These labels will help investors and consumers identify, compare, and make informed decisions about sustainable investment products to understand what ‘sustainable’, ‘green’ or similar words mean when they’re applied to financial products.”

Although introducing standardisation of these labels would help, Higgins said the most immediate issue is the scope for labelling.

“Across the US, Europe and Asia Pacific, sustainability themed funds are usually less than 5 per cent of AUM. However, funds that use ESG as a decision-making tool is far more widespread (our data suggests that locally around 75 per cent of funds incorporate ESG to some extent). That boundary would therefore be very wide,” Higgins said.

“So whether to make labels applicable to all products (the EU model) or only those making sustainability claims (the UK model) is key. This is also important as some existing frameworks apply at the fund level, others only at the manager level.

“This creates greater complexities for large asset managers with multiple capacities as this doesn’t readily distinguish between an index tracking fund with no ESG or sustainability considerations, and an impact fund with high ESG and sustainability applications, being operated by the same manager.”

As an added benefit, he suggested that standardisation and clarity for labelling would also make funds more easily comparable for investors and advisers to help them select the right product.

This point was likewise raised in the Treasury paper, stating that the “diversity of practice can make it difficult for investors to understand whether or how different products meet their investment objectives. Existing financial product disclosure obligations do not support simple comparisons of the sustainability characteristics of financial products”.