Peeking behind the screen: ASIC's second greenwashing proceeding should prompt action by financial product issuers

Emily Tranter, Matt Spain, Lucy Walsh and Margit Baranyay
25 Jul 2023
Time to read: 5 minutes

Product issuers relying on ESG research performed by external providers as part of the product issuer's exclusionary screens should be on alert, following ASIC's second greenwashing case against Vanguard, almost five months after its first against Mercer.

While the outsourcing of such ESG research is common in the industry, this proceeding will cause product issuers to take stock and consider the following steps:

  • Review any external researcher to understand the precise nature of the research being conducted and its practical application to the product issuer's products and funds to ensure they are working how the product issuer says that they are.
  • Review their PDSs and other marketing and promotional materials, such as websites and other online presence, to ensure that:
    • any limitations with the research they outsource are plainly and clearly identified;
    • those materials are not otherwise misleading having regard to any limitations with the research;
    • the product name is true to label.
  • Conduct an analysis as to whether the current (and, if desired, historical) investments related to the product violate the claims and statements made in their marketing and promotional materials.
  • Consider whether their processes for media interviews and presentations, and the review and approval of what is said at such events, should be revised, as statements made on such occasions will be a focus for ASIC.

It is noteworthy that this proceeding was commenced by ASIC even though Vanguard sought to rectify the alleged greenwashing conduct in relation to its product (Vanguard Ethically Conscious Global Aggregate Bond Index Fund (Hedged)) by making updates to its PDSs and website in February 2021, almost 18 months before ASIC issued its Information Sheet 271 on how to avoid greenwashing when offering or promoting sustainability-related products.

While product issuers cannot change the past, this proceeding indicates that it may come back to haunt them with ASIC taking action in relation to historic conduct.

A screening evolution

The claim focuses on whether ethically conscious exclusionary screens were applied effectively by Vanguard. This is not the first time that ASIC has taken action against Vanguard or other players in the industry relating to exclusionary screening: it has previously issued infringement notices in relation to Cruelty Free Super, and three of Vanguard's International Shares Select Exclusions Funds.

There was no suggestion in the Cruelty Free Super or Vanguard infringement notices that the ESG criteria being screened had in fact been violated. In the Cruelty Free Super infringement notice, ASIC's focus was on the design of the screen itself. For example, ASIC alleged that the screen applied did not assess or seek to exclude companies engaged in activities such as "carbon intensive activities" or "polluting", outside of the context of the destruction of "valuable environments".

The Vanguard infringement notices suggested that Vanguard's description of the exclusionary screens were not accurate as the MSCI Indexes that the relevant Vanguard products were seeking to track and mirror only excluded securities involved in the production and manufacturing of cigarettes and other tobacco products. ASIC alleged that the relevant PDSs also stated that companies involved in the sale of tobacco would be excluded, when this was not the case. As with Cruelty Free Super, the infringement notices did not identify any specific violation of the ESG criteria being screened for. Rather, they identified a misrepresentation of what was being screened.

The proceeding issued against Vanguard is different: ASIC alleges that the screened ESG criteria were violated (not effectively implemented) and there were alleged misrepresentations as to what was being screened for.

What is the specific greenwashing claim against Vanguard about?

ASIC alleges Vanguard made false and misleading statements that all securities in the Vanguard Ethically Conscious Global Aggregate Bond Index Fund were screened against certain ESG criteria.

Part of Vanguard's marketing included a focus on investors seeking securities with an ethically conscious screen.

The Fund was based on the Bloomberg Barclays MSCI Global Aggregate SRI Exclusions Float Adjusted Index and the ESG research was performed by MSCI ESG Research and provided to Bloomberg for use in the index.

Vanguard claimed in its PDSs that the Index excluded issuers with "significant business activities involving fossil fuels, alcohol, tobacco, gambling, military weapons and civilian firearms, nuclear power and adult entertainment". In bringing the claim, ASIC has also focussed on alleged misleading statements made by Vanguard:

  • in media releases;
  • on its website; and
  • in media interviews with Finance News Network and at a Finance News Network Fund Manager Event.

However, ASIC alleges that contrary to these statements, the ESG research was not conducted over a significant proportion of the issuers of bonds in the index and therefore the fund, meaning that investors were exposed to investments with ties to fossil fuels (including activities linked to oil and gas exploration).

In particular, ASIC alleges that:

  • not all issuers were researched and screened for exclusion – rather, only companies were researched and screened, which meant that issuers in the treasury and securitised sectors, and many government-related and private companies were not researched or screened;
  • for companies with multiple issuing entities that shared a particular stock exchange "ticker", the ESG research was not conducted on each entity, rather the research was only conducted for the company with the largest debt outstanding and was applied to all other companies within the same "ticker"; and
  • MSCI's fossil fuel screen did not cover companies that derived revenue from the transportation or exploration of thermal coal.

The limitations with the research are alleged to have the effect that:

  • a significant proportion of bonds in the Index and the Fund were from issuers that were not researched or screened against the applicable ESG criteria – for example, in February 2021, 46% of bonds in the Fund and 74% of bonds in the Fund by market value were from issuers that were not researched by MSCI; and
  • the Index and Fund included issuers that violated the applicable ESG criteria, including but not limited to:
    • in respect of the Index: 42 issuers which collectively issued at least 180 bonds; and
  • in respect of the Fund: 14 issuers which collectively issued at least 27 bonds.

The proceedings were commenced by ASIC notwithstanding that Vanguard issued a supplementary PDS in February 2021 that stated:

"Investors should be aware that the Index provider's screening process does not review government bonds, securitised fixed rate bonds and some company structures, particularly government related corporations and non-listed companies, for ties to these business activities. Bonds issued by these non-screened entities may still be contained in the ETF."

At the same time, Vanguard updated a statement on its website to read:

"In constructing the Index, using MSCI research, Bloomberg Barclays (the Index provider) excludes the securities of issuers that engage in activities in, and/or derive revenue (above a threshold specified by the Index provider) from, fossil fuels, nuclear power, alcohol, tobacco, gambling, weapons and adult entertainment. This index methodology also excludes the securities that have a controversy score above a threshold specified by MSCI. Where MSCI has insufficient or no data available to adequately assess a particular security relative to the ethically conscious criteria of the Index, these securities may not be excluded".

How confident can you be about your green claims for your financial products?

The enforcement actions comes at the same time as ACCC has issued detailed greenwashing guidance. Apart from regulators, activists are also bringing investor actions against companies over their climate-related action plans and claims. For example, ClientEarth's proceeding against Shell's directors has just been dismissed by the UK High Court on the basis that ClientEarth's case ignored that managing large businesses requires directors to "take into account a range of competing considerations", in which courts should not interfere.

With that increased pressure, issuers might be looking at remedial action. Our team has conducted current and historic reviews of promotional and marketing materials, and compliance and screening processes, in relation to a variety of products, but a full-scale review is often not desired or warranted.

Using "spot checks" and "scraping" technology for conducting greenwashing assessments can sometimes be a better option for identifying the risks associated with a product's marketing and promotion to ensure that swift forward looking remedial action is taken.

We would welcome the opportunity to discuss this with you or provide a second opinion on any internal or external analysis already undertaken.

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.