Trend color green

In the face of the world financial crisis, intensifying social conflicts and the threat of global ecocide, no financial or real company wants to be accused of having an unsustainable business model. Meanwhile, target groups are learning to distinguish serious sustainability efforts from green-colored business as usual.

Above all, the capital markets would have the power to promote sustainable investments, and even to curb climate change. However, not all players are immune to mere greenwashing. The trend toward green financial products is nevertheless (or precisely because of this) unbroken. While $168.5 billion worth of green bonds were issued worldwide in 2018, the volume in 2019 was 263 billion. For 2020, up to 375 billion are expected.

Institutions and institutes in the financial system are also pursuing green finance initiatives. For example, both BaFin and the Bundesbank are among the founders of the “Network for Greening the Financial System,” which analyzes the consequences of climate change for the financial sector and directs capital flows toward low-carbon economic growth. An increasing number of green banks invest according to ecological and ethical criteria.

But what does this market trend contribute to environmental protection? How trustworthy are such financial products? As long as the use of attributes such as sustainable or green is at the discretion of the provider, investors should exercise caution. Anyone who wants to be sure of the environmental sustainability of an investment should not rely solely on a green rating.

Missing scale

A major problem in choosing a green financial product is the lack of a recognized valuation benchmark that could be applied to all asset classes. With its proposal to introduce a European green bond standard, the EU Commission aims to improve the effectiveness, transparency, comparability and credibility of the green bond market and encourage its players to issue or invest in such securities.

The Brussels European & Global Economic Laboratory (Bruegel), a think tank supported by European states, banks and real companies, advises the Commission that the comprehensive taxonomy it is striving for must be flexible enough to do justice to the complexity and dynamics of the market. The target groups of the standard are therefore called upon to negotiate with each other how binding the regulations on green financial products can and must be, so that they neither set too high hurdles nor offer loopholes. It must also be decided which institutions should be responsible for formulating the standard, how it is to be implemented technically, and what private investors can contribute.

Through green glasses

It is not only the lack of a standard that makes it difficult to assess the environmental relevance of business models and investment products. There is also a structural information deficit: hardly any companies publish enough information on sustainability criteria such as resource consumption, pollutant emissions or supply chain to derive comparative key figures. This is why potential investors usually rely on analysts to assess the environmental performance of a company or financial product.

American financial scientists have studied such analysts’ opinions. Their findings cast doubt on whether market observers are always right. Among other things, the researchers found that the more difficult the prediction, the more analysts tend to be cognitively biased and optimistic when forecasting stock prices. Another study showed that analysts tend to apply double standards to companies’ social actions: Improvements are more likely to be registered than failures.

In addition, there are universal cognitive mechanisms that make it difficult for humans to judge objectively, including the anchor effect: When making estimates and decisions, we unconsciously orient ourselves to so-called anchors – associated memory contents or information from the context. These have an effect even if they are factually irrelevant or objectively wrong. For example, a solidified green image can cloud analysts’ judgment regardless of a company’s actual eco-balance. A similar thinking error is the availability heuristic: in the absence of exact data, we assess the frequency or probability of an issue or event according to the presence of relevant information in memory, the mass media, or some other readily available source. For example, a current green showcase may cause a corporate analyst to disregard last year’s environmental scandal.

Intransparency and bias

Interim conclusion: The rating of green financial products is subject to cognitive bias and intransparency. Before such products are launched on the market, their issuers usually submit them to an external service provider, such as a rating agency, for review. However, it is difficult for potential investors to understand which criteria are decisive in this process.

Even if an official world standard for assessing sustainable investments were introduced and proved reliable, hardly any agency would publish the observations and calculations on which the grade is based in individual cases. And even if this data were available, the decision would still rest with a committee whose members represent vested interests, ergo are biased. But the World Bank is not alone in believing that the green bond market can only grow in the long run if it becomes more transparent. Michael Wilkins, infrastructure finance analyst at S&P, also states: “Green bonds are still uncharted territory. How they evolve depends largely on the credibility of the issuing companies and the standards they set and adhere to.”

Our approach

The state of the world requires a rethink. Consileon is leading the way. Our experts tap sources of insight, evaluate their information using proven and new methods ranging from data mining to artificial intelligence, and network them both with each other and with current expertise. Real-time opinion analyses show what is currently on the minds of the target groups. Methods and tools from computational linguistics (natural language processing, NLP) can be used, for example, to evaluate speeches at board level or investor meetings. AI applications can be trained to identify discrepancies between a company’s public communications and its actions. Tools developed specifically for analysts help avoid cognitively biased decisions by detecting information that challenges preconceptions or thought patterns.

A classification that realistically categorizes the environmental added value of green financial products is urgently needed. To help our clients seize the opportunities of economic and socio-ecological change, we closely monitor the development of business models and products that reconcile financial gain with environmental protection and participate in many projects to do so. Do you have any questions or would you like to expand your company’s ecological expertise? Then we look forward to hearing from you. More about our services for capital market players at: