Controversy monitoring: developments and best practices

Incorporating controversy monitoring into the investment process is a widespread practice in the marketplace. A controversy refers to the involvement of a public or private issuer in ESG-related incidents. As with all sustainability issues, controversies can be environmental, social or the result of corporate governance practices.

Consequently, the emergence of a controversy is always associated with a negative impact on the ecosystem and stakeholders of a company. For the company, this represents a risk to its activities and reputation. For an investor, an additional risk of greenwashing can arise from holding positions in a controversial company: it is therefore essential to establish an effective alert system that allows for identifying past and present controversies and anticipating future controversies associated with an issuer.

Observations

In June 2023, WeeFin published the sustainable finance barometer taking stock of asset managers' ESG & impact practices, based on a panel of 50 Article 8 and 9 funds as defined by SFDR.

Controversy tracking was already an area of analysis in the 2023 barometer, as it provides a dynamic, up-to-date view of the practices of the entities in which the fund invests, whereas ESG data is a view of past practices (from the N-1 or even N-2 report).

This year, we wanted to repeat this analysis, while at the same time refining it: for 75 portfolios, we checked whether systematic, formalized monitoring of ESG-related controversies was in place (regular, even continuous monitoring, escalation process, comitology, etc.). Thus, the new data collected deals separately with funds for which no monitoring of controversies is carried out and funds for which such monitoring, although existing, does not provide a dynamic and up-to-date view of issuers' practices (for example, in the case of a non-formalized and systematized monitoring process). In both cases, the probability of investing in companies whose practices run counter to environmental, social and good governance principles remains high, increasing the risk of greenwashing.

Our study revealed that 78% of asset managers have deployed a sufficiently robust controversy management procedure to ensure that ESG risks are under control! These results are encouraging: most players are effectively preventing the risk of greenwashing by giving controversy management an appropriate place in their investment strategy. Nevertheless, the existence of shortcomings in the controversy monitoring practices of certain management companies was also highlighted.

The following results were observed:

• 12% of the funds analyzed have not yet defined a monitoring process to identify potential and proven controversies;
• 22% of the funds analyzed have integrated a controversy watch into their investment process, but their monitoring is insufficiently formalized and systematized.

How to explain these results?

The results of the analysis carried out in 2024 remain positive: they are linked to an awareness of the seriousness of the risk that controversies can represent throughout the financial sector, in reaction to the growing number of ESG scandals. As a result, the various financial professions have worked to deploy ambitious controversy management policies, organizing data collection on the one hand, and formalizing controversy monitoring procedures on the other. However, controversy management is a complex exercise, and management companies may encounter difficulties in implementing and enforcing their policies. In particular, three issues may hold players back:

1. Firstly, to date, there is no regulatory framework to guide financial companies in integrating controversies into their investment strategies (only the French regulator has issued recommendations). However, some labels (SRI, Greenfin, Towards Sustainability) are beginning to include controversy-related criteria in their requirements.

2. Secondly, exhaustive monitoring of controversies requires covering a considerable perimeter of issuers, since no economic activity is immune to this risk. Some sectors of activity are more exposed to ESG scandals than others: this is the case of the textile, agri-food and real estate sectors, which may be subject to particularly serious and/or frequent controversies. Nevertheless, it is impossible to exclude the possibility of disputes arising in a less exposed company, which is why it is almost always necessary to call on external private data providers. This means devoting substantial economic, technical and human resources to obtaining ESG data and integrating it into controversy management in a relevant way.

3. Finally, it is difficult for players to define a process for dealing with controversy and escalation that does not have an excessive impact on their investment strategy. When an investor holds positions on an asset that is the subject of controversy, one of the only possible responses is to sell these positions quickly. On the one hand, however, this response is highly restrictive in terms of the company's financial objectives. On the other hand, selling may be made impossible by the low liquidity of the controversial securities.

For all these reasons, some players remain exposed to the risk of greenwashing when managing controversies.

How to prevent the risk of greenwashing?

Expertise:

• Continuous monitoring to ensure the broadest possible coverage of portfolio companies;
• Define a classification of controversies and create an escalation process for managing controversies once they have been identified.

Data :

• Use data from private and public suppliers to classify controversies appropriately;
• Develop ESG rating methodologies and identify indicators to be monitored, enabling us to anticipate cases of controversy by highlighting alarming elements (e.g. high turnover rate, increase in waste rate, etc.).

Tools :

• Bring together all the processes associated with controversies in a single tool, from monitoring, analysis and application of an escalation process to decision-making in committee;
• Use tools that link controversies to investment and engagement processes

‍