ASIC files greenwashing case against Vanguard Investments

ASIC’s strategic focus on greenwashing conduct in the funds sector continued this week, with the regulator commencing Federal Court proceedings against one of the world’s biggest investment managers, Vanguard Investments (Vanguard).

ASIC alleges that Vanguard engaged in misleading conduct in relation to claims it made about certain environmental, social and governance (ESG) exclusionary screens which applied to investments in its Ethically Conscious fund.^[1] It is seeking declarations, pecuniary penalties and adverse publicity orders against Vanguard.

This case follows a range of regulatory actions ASIC has taken in the superannuation fund sector and the wholesale green bond market over the last year, including its first greenwashing Court case against retail super giant, Mercer Super, earlier this year, and 3 infringement notices being issued to Vanguard for greenwashing conduct in December 2022.^[2]

The Vanguard prosecution provides further important takeaways for fund managers and operators about ensuring ESG related disclosures are precise and verifiable.

     1. What is the case about?

The case concerns the Vanguard Ethically Conscious Global Aggregate Bond Index Fund (Hedged) (Fund). The Fund was designed to track the return of a third-party index (being the Bloomberg MSCI Global Aggregate SRI Exclusions Float Adjusted Index, Index). This Index was designed such that to be included securities needed to meet certain ESG criteria.

Between August 2018 and February 2021, Vanguard is alleged to have made public statements to the effect that on this basis, the Fund excluded companies with significant business activities involving fossil fuels, alcohol, tobacco, gambling, weapons, nuclear power and adult entertainment. The statements are alleged to have been made via published product disclosure statements (PDSs) for the Funds, fact sheets, in a media release, on its website and in interviews and presentations (collectively, the Representations). The Representations were allegedly reinforced by the name of the fund, which included the words “Ethically Conscious”.

ASIC claims that the Representations provided the following misleading impressions:

• securities were researched and screened to assess whether or not they met the applicable ESG criteria before inclusion in the index (and subsequently the Fund); and
• securities that did not meet the applicable ESG criteria were excluded or removed from the Index and therefore the Fund.

This was misleading because the relevant research and screening methodology (being that adopted by the Index) had various limitations which were not disclosed, including:

• exclusion of issuers in treasury, securitised and many government-related and private companies;
• for companies with multiple issuing entities that shared a stock exchange “ticker”, the ESG research was only conducted for the company with the largest debt outstanding; and
• the fossil fuel screen did not cover companies that derived revenue from the transportation or exploration of thermal coal.

ASIC alleges that as a result of the above undisclosed limitations, the majority of bonds in the Fund by market value (~74%) were from issuers that were not researched and there were 14 issuers in the Fund that violated the applicable ESG criteria. Examples of companies that investors were exposed to that contravened the ESG criteria include Abu Dhabi Crude Oil Pipeline LLC and Chevron Philips Chemical.

The proceedings follow Vanguard having self-identified and taken steps to correct some of the alleged limitations, including issuing supplementary and updated PDSs in February 2021.

     2. What are the key takeaways for fund managers?

          a. More to come…

ASIC is continuing to place significant and ongoing focus on greenwashing, with particular surveillance of the funds sector, ESG-related disclosures generally, and is using much of its regulatory toolkit to respond to reports of misconduct.

In addition to the Vanguard case, from 1 July 2022 to March 2023 ASIC has issued:

• 23 corrective disclosure outcomes,
• 11 infringement notices; and
• one additional civil proceeding (being the proceeding against Mercer, noted above).

Those actions related, for example, to “net zero” statements / targets and the use of terms like “carbon neutral”, “clean” or “green”, where ASIC considered those statements lacked a reasonable basis.

ASIC surveillance is only likely to intensify, with the superannuation fund sector, the wholesale green bond market, managed funds and the corporate sectors all in the spotlight. The regulator has a number of ongoing greenwashing investigations, and has indicated it will be taking a particularly tough stance in relation to representations by superannuation funds, given its compulsory nature.^[3]

ASIC has stated that it will also expand its scrutiny of greenwashing conduct once climate-related financial disclosure laws are settled (with a Federal Government consultation paper released in June this year).^[4] It is likely this could include examining super funds’ direct ESG commitments to its members, including their targets for transitioning to net zero or other ESG related pledges. Increasing expectations around ESG compliance should provide funds with added motivation to ensure their approach to compliance in this space remains holistic and subject to continual review.

          b. Stay true to label and review your investment screening processes

The Vanguard case shines a light on the scope and application of investment screening processes, and whether they sufficiently support representations about how funds are invested. Clear disclosure of the process for screening is important. The effectiveness or scope should not be overstated, and any exclusions or limitations should be accurately and prominently reflected.

Moreover, particular care should be taken to ensure fund names stay true to label and live up to investors’ reasonable expectations about the ESG related characteristics being promoted. In this case, ASIC took issue with the fact that the Fund name containing the phrase, “Ethically Conscious”, which is alleged to have further reinforced the misleading representations.

          c. Prevention is better than cure: Self-reporting and good intentions after the event will not necessarily prevent prosecution

A proactive stance by market participants appears to be the best protection against regulatory action in relation to greenwashing. In this case, ASIC commenced proceedings despite Vanguard:

•  identifying and self-reporting a breach in relation to disclosures for the Fund in 2021 and fully cooperating with ASIC’s investigations; and
• subsequently publishing updated statements in its PDS that warned investors about the limitations identified above and taking steps to correct these limitations, including removing all previous Representations.

^[1]  Vanguard has $11 trillion in assets under management globally, and for the Fund discussed in this article, as at February 26, 2021, the total funds or assets under management in the Fund was over $1 billion.

^[2]  Refer to ASIC’s greenwashing interventions (May 2023) report - https://download.asic.gov.au/media/ao0lz0id/rep763-published-10-may-2023.pdf.

^[3]  See ASIC’s greenwashing interventions (May 2023) report, and the article ‘ASIC pursues ‘several’ super funds for greenwashing, expects court actions’, Australian Financial Review, 13 March 2023

^[4]  Australian Government: “Climate-related financial disclosure” Consultation Paper (June 2023) - https://treasury.gov.au/sites/default/files/2023-06/c2023-402245.pdf.