FINANCIAL REPORTING & IR

This column is a summary of content originally published by our KPMG colleagues Becky Seidler and Nishitha Parial about the ways in which ESG initiatives and impact can be misrepresented and undermine otherwise good ESG programs.

There continue to be growing expectations regarding companies’ environmental, social and governance (ESG) practices. Investors are increasingly scrutinizing their portfolio companies, employees are seeking companies that align with their values, and consumer spending behaviour is shifting in favour of ESG ideals. In response, companies are coming forward with bold ESG commitments, such as reaching net-zero emissions by a target date. In some cases, companies go as far as linking their ESG commitments to executive compensation. These pressures can incentivize misrepresentation, overstatement or even fraud concerning an organization’s ESG claims, products and financial reporting.

‘ESG washing’ is the emerging term used to characterize the business practice of embellishing and overselling ESG efforts and initiatives to gain a favourable impression from investors, employees, consumers and other stakeholders. Below are some common types of ‘ESG washing’ and the terminology that is emerging:

• Greenwashing refers to when organizations misrepresent corporate initiatives as environmental initiatives when, in reality, such initiatives are used to further other objectives and have little or no environmental impact. Carbon washing is a form of greenwashing focused on misrepresentation of reduced carbon emissions, achieved by overstating either (or both) the actual reduction of carbon emissions or carbon offset credits.
• Purplewashing refers to organizations that present themselves as committed to diversity, inclusion and the advancement of women but maintain internal practices significantly inconsistent with this messaging. Pinkwashing refers to companies that use the pink ribbons associated with breast cancer awareness to promote their products but provide little to no transparency on their involvement or production of cancer-causing products.
• Rainbow washing (sometimes called pinkwashing) refers to companies that advertise their support and sponsorship of 2SLGBTQIA+ employees but do little to protect this community from discrimination, prejudice, or harassment.
• Similarly, brownwashing refers to when organizations create an insincere public image that supports Black, Indigenous and People of Colour (BIPOC) communities. Redwashing is when organizations show public support for Indigenous initiatives while doing little or nothing to support, advance or protect these communities.
• And finally, whitewashing occurs when an organization is called out for misrepresentations and, in an attempt to cover up its failures, announces investigations that are ultimately carried out with little effort or biased data.

While many responsible organizations are, in fact, making very positive strides in ESG practices, stakeholders must continue to be alert to risks that can compromise otherwise effective initiatives. It’s clear that a brighter spotlight has been directed at corporate ESG practices and reporting. With that comes increased expectations and pressures as stakeholders elevate the importance of ESG on their agendas.

Consider this:

• An effective strategy proactively managing ethics, compliance, and fraud risk throughout the organization can establish and instill trust with stakeholders as ESG expectations and practices evolve. The foundation of an effective strategy consists of both preventive and detective measures. Existing control frameworks should include consideration of ESG-related risks. For example, is management setting an appropriate tone at the top to emphasize the importance of ESG integrity, and does that message translate down to frontline employees through appropriate training and communications?
• Do the company’s policies, procedures and internal controls address ESG-related risks in the supply chain (such as bribery and corruption), non-financial disclosures (such as ESG metrics), and human resources (such as human rights issues)?
• While the finance function may have well-established internal controls, the responsibility for some ESG metrics may sit with functions that do not have this discipline, such as investor relations, marketing, legal and/or operations.

Detection mechanisms – which can help ensure any potential problems are identified and able to be dealt with quickly and appropriately – include being aware of ‘red flags,’ such as too good to be true ESG metrics that consistently exceed or meet targets exactly, unexplained or unusual changes in metrics calculations and measurements and unbalanced or vague reporting of metrics. Using hotlines and whistleblower mechanisms to alert management and allow it to respond to potential ESG misconduct helps avoid people turning to social media channels to voice concerns. By the time concerns have made it to social media, it is far more challenging to undo the damage to corporate reputation.

As organizations go through their ESG journey, the best approach is balanced. Avoid exaggerating progress, or setting unachievable objectives, whether in communicating with employees, customers or investors. Instead, be mindful of the red flags, build the risk safeguards and stay transparent about progress and where room for improvement still exists. Investor relations professionals play a key role in that journey, helping to chart a responsible course and dealing with the aftermath of irresponsible communications.

Keith Leung, CPA, CA is a Senior Manager, Accounting Advisory Services, and Rob Brouwer, FCPA, CPA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.