The illusion of integrity: Confronting governance washing in sustainable investing

Understanding governance washing

Governance washing occurs when companies, particularly fund managers, attempt to deceive stakeholders, including investors, by portraying themselves as more committed to governance principles than they truly are. Specifically, governance washing often rears its head when companies face pressure to align with ESG standards or when scandals threaten their reputation. In such situations, rather than implementing genuine reforms, they resort to surface-level changes to maintain appearances and preserve investor confidence. This phenomenon happens a lot in ESG investing, where the demand for socially responsible investment options has surged.

Consequences of governance washing

The consequences of governance washing extend beyond mere reputational damage. Investors relying on misleading governance disclosures may unknowingly allocate capital to companies with weak governance structures, exposing themselves to financial risks. Moreover, governance washing erodes trust in ESG investing and impedes progress towards sustainable and ethical business practices. Additionally, significant drops in the stock market price. Examples of governance washing and the impact on business continuity can be found below.

1. Wells Fargo's board oversight failures: In the aftermath of the Wells Fargo fake accounts scandal, the bank's board made public statements about holding executives accountable and enhancing oversight. However, critics argued that these measures were insufficient, suggesting governance washing tactics.
2. Volkswagen's emissions scandal: Volkswagen admitted to installing software to cheat emissions tests, exposing lapses in oversight and compliance. Despite claims of robust corporate governance structures, critics argued that Volkswagen engaged in governance washing to conceal ethical breaches.
3. Enron's corporate governance scandal: Enron's collapse due to accounting fraud highlighted governance failures within the company. Critics argued that Enron engaged in governance washing by presenting itself as successful and innovative while masking deceptive practices.
4. Woodford’s ‘sin’: One of the biggest scandals and longest-running loss-hiding arrangements in Japanese corporate history. The company incurred substantial asset impairment charges in its accounts due to irregular payments made for acquisitions. This corruption scandal entailed the concealment of over 117.7 billion yen ($1.5 billion) in investment losses and questionable fees, along with suspicions of covert payments to criminal syndicates. By 2012, the scandal had decimated 75–80% of the company’s stock market valuation and prompted the resignation of a significant portion of the board.
5. Boohoo: The UK-based online fashion retailer faced allegations of poor working conditions and workers exploitation in its supply chain in 2020. Reports revealed low wages and unsafe working conditions in factories supplying Boohoo. The scandal led to a significant drop in Boohoo's stock price and raised concerns about the company's corporate governance and ethical practices.

* Example of a reference as optional

Tackling governance washing

To combat governance washing effectively, regulatory authorities, investors, and stakeholders must demand greater transparency and accountability from companies. Regulators can strengthen disclosure requirements and enforce stricter penalties for misleading governance reporting. Investors should conduct thorough due diligence and engage with companies to ensure alignment with genuine ESG principles. Regulations and initiatives are already in place to support these efforts.

For instance, Principles for Responsible Investment (“PRI”) provide guidance for incorporating ESG factors into investment decisions. Initiatives such as the Corporate Sustainability Reporting Directive (“CSRD”) represent an initial effort to clarify ESG governance criteria, indicating a move towards transparency and consistency. However, achieving comprehensive transparency and consistency requires additional time and information. Moreover, the Council and European Parliament have agreed on a proposal to regulate ESG rating activities, aiming to bolster investor confidence in sustainable products. The new rules focus on improving transparency and integrity by requiring ESG rating providers to be authorized and supervised by ESMA, and to comply with transparency requirements regarding methodology and information sources.

Establishing a seamless governance model is crucial to facilitating ESG integration. This entails assigning designated teams with the responsibility to develop policies and processes that steer the company’s operations toward ESG objectives. Additionally, the ESG team ensures the implementation of tools to manage ESG adaptation, facilitating both internal and external disclosure for reporting, regulatory compliance, and financial purposes.

Corporate governance codes serve as vital tools in preventing governance washing by fostering transparency, accountability, and ethical conduct within companies. These codes establish clear standards, mandate comprehensive disclosure, advocate for independent oversight, and encourage shareholder engagement. By adhering to them, companies can ensure compliance with governance standards, maintain stakeholder trust, and mitigate the risk of engaging in deceptive practices to improve their public image. Indicative examples of prominent corporate governance codes include the OECD Principles of Corporate Governance, which provide a comprehensive framework for governance practices, the UK Corporate Governance Code, which outlines principles for UK-listed companies, and the Dutch Corporate Governance Code, which focuses on board composition, shareholder rights, financial reporting, and risk management of public listed Dutch companies.

The fear of green hushing

Adhering to the above solutions is time-consuming and requires a shift in mindset. Additionally, in the last year, we have seen a new term emerge, known as "green hushing," where companies downplay their environmental impacts to avoid scrutiny. Much like governance washing, green hushing obscures vital information, in this case regarding environmental practices, which destroy transparency and fosters a culture of deception. Governance washing and green hushing are two sides of the same coin, representing the dangers of superficial sustainability practices and the urgent need for genuine corporate responsibility. By exposing and addressing this deceptive practice, stakeholders can uphold the principles of transparency, accountability, and sustainability in the pursuit of a more responsible and equitable financial system.

In conclusion, governance washing undermines the credibility of ESG investing and threatens the integrity of corporate governance frameworks. By exposing and addressing this deceptive practice, stakeholders can uphold the principles of transparency, accountability, and sustainability in the pursuit of a more responsible and equitable financial system. It is imperative for regulatory authorities, investors, and stakeholders to remain vigilant and demand greater transparency and accountability from companies +to combat governance washing effectively.

* Example of a reference as optional