Greenwashing in light of the new ESAs progress reports

Introduction

Greenwashing is a term used to describe the practice of making false or misleading claims about the environmental benefits of a product, service, or investment.^[1] In the context of sustainable finance, greenwashing can have serious consequences for both financial institutions and investors.^[2]

One of the main risks associated with greenwashing is reputational damage. Financial institutions that engage in greenwashing can damage their reputation and lose the trust of their clients and stakeholders. This can lead to a loss of business and a decline in the institution’s financial performance.

Another risk associated with greenwashing is legal liability. Financial institutions that make false or misleading claims about the environmental benefits of their products or services can be held liable for misleading advertising or fraud. This can result in legal action, fines, and other penalties.

Greenwashing can also have a negative impact on investors. Investors who are misled by false or misleading claims about the environmental benefits of an investment may make decisions based on inaccurate information. This can lead to financial losses and a decline in investor confidence in sustainable finance.

To address the risks associated with greenwashing, it is important to have a clear understanding of what greenwashing is and how it can be identified. The European Supervisory Authorities (ESAs) have provided a high-level understanding of greenwashing, which includes the following characteristics:

1. Misleading claims: Greenwashing involves making false or misleading claims about the environmental benefits of a product, service, or investment.
2. Lack of transparency: Greenwashing often involves a lack of transparency about the environmental impact of a product, service, or investment.
3. Inconsistency: Greenwashing can involve inconsistencies between a company’s environmental claims and its actual environmental performance.
4. Irrelevance: Greenwashing can involve claims that are irrelevant to the environmental impact of a product, service, or investment.

By understanding these characteristics, financial institutions and investors can better identify and avoid greenwashing. This can help to protect the reputation of financial institutions, reduce legal liability, and ensure that investors have accurate information about the environmental impact of their investments.

Drivers of Greenwashing in the Financial Sector

The increasing demand for sustainable finance has created a market for financial products and services that are marketed as environmentally sustainable. This has led to a proliferation of green financial products and services, some of which may not be genuinely environmentally sustainable.^[3] Consequently, the lack of a clear and consistent definition of sustainable finance has created confusion among financial institutions and investors about what constitutes environmentally sustainable investments. This has made it easier for financial institutions to make false or misleading claims about the environmental benefits of their products and services. Finally, the absence of materiality benchmarks to identify greenwashing has made it difficult for regulators to assess the impact of greenwashing on the risk profile of financial institutions.

The role of European Supervisory Authorities in addressing greenwashing

The European Supervisory Authorities (ESAs) play an important role in addressing greenwashing in the financial sector. The ESAs are composed of three authorities: the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority (ESMA). These authorities are responsible for ensuring the stability and integrity of the financial system in the European Union (EU).

In May 2023, the ESAs published three reports on the risks and opportunities of sustainable finance, highlighting the risks associated with greenwashing and the need for greater transparency and accuracy in sustainable finance.^[4] The reports also provided a high-level understanding of greenwashing, which includes the characteristics mentioned in the previous section.

The ESAs have also provided recommendations for financial institutions to address the risks associated with greenwashing. These recommendations include:

1. Developing a clear and consistent approach to sustainable finance: Financial institutions should develop a clear and consistent approach to sustainable finance that is aligned with their business strategy and values. This approach should be communicated clearly to clients and stakeholders.
2. Ensuring transparency and accuracy: Financial institutions should ensure that their environmental claims are transparent and accurate. This includes providing clear and detailed information about the environmental impact of their products and services.
3. Conducting due diligence: Financial institutions should conduct due diligence to ensure that their investments are consistent with their environmental objectives. This includes assessing the environmental impact of their investments and monitoring their performance over time.
4. Engaging with stakeholders: Financial institutions should engage with stakeholders, including clients, investors, and regulators, to ensure that their approach to sustainable finance is aligned with their expectations and needs.

The ESAs have also called for greater regulatory and supervisory action to address greenwashing. This includes the development of a common EU taxonomy for sustainable finance, which would provide a clear and consistent framework for identifying environmentally sustainable activities. The ESAs have also called for greater disclosure requirements for financial institutions, including the disclosure of their environmental objectives and the environmental impact of their investments.

The ESAs’ High-Level Principles for financial institutions

To address the issue of greenwashing, the ESAs have proposed a set of core principles that financial institutions should follow. These principles include:

1. Transparency: Financial institutions should be transparent about their environmental objectives and the environmental impact of their products, services, and investments. This includes providing clear and detailed information about the environmental impact of their investments and the criteria used to assess their environmental impact.
2. Accuracy: Financial institutions should ensure that their environmental claims are accurate and supported by evidence. This includes using industry standards and best practices to assess the environmental impact of their investments.
3. Consistency: Financial institutions should ensure that their environmental claims are consistent with their environmental practices and industry standards. This includes aligning their environmental objectives with their business strategy and values.
4. Relevance: Financial institutions should ensure that their environmental claims are relevant to the environmental impact of their products, services, and investments. This includes focusing on the most significant environmental impacts of their investments and avoiding claims that are not relevant to the environmental impact of their products or services.

By following these core principles, financial institutions can help to promote greater transparency and accuracy in sustainable finance and reduce the risks associated with greenwashing.

Existing and Upcoming Regulatory and Supervisory Frameworks to Address Greenwashing

The ESAs have identified a number of existing and upcoming regulatory and supervisory frameworks that can help to address greenwashing in the financial sector. These frameworks include:

1. The EU Taxonomy for Sustainable Finance: The EU Taxonomy is a classification system that provides a clear and consistent framework for identifying environmentally sustainable activities. The Taxonomy is designed to help investors and financial institutions identify investments that are consistent with their environmental objectives and avoid investments that are not environmentally sustainable.
2. The Non-Financial Reporting Directive: The Non-Financial Reporting Directive requires large companies to disclose information about their environmental, social, and governance (ESG) performance. This includes information about their environmental objectives and the environmental impact of their products and services.
3. The Sustainable Finance Disclosure Regulation: The Sustainable Finance Disclosure Regulation requires financial institutions to disclose information about the environmental impact of their investments. This includes information about the environmental objectives of their investments and the criteria used to assess their environmental impact.
4. The EU Action Plan on Sustainable Finance: The EU Action Plan on Sustainable Finance is a comprehensive plan to promote sustainable finance in the EU. The Action Plan includes a range of measures to promote greater transparency and accuracy in sustainable finance, including the development of the EU Taxonomy and the Sustainable Finance Disclosure Regulation.
5. The Green Bond Standard: The Green Bond Standard is a voluntary standard for green bonds that provides a clear and consistent framework for identifying environmentally sustainable investments. The Standard is designed to help investors and financial institutions identify green bonds that are consistent with their environmental objectives and avoid green bonds that are not environmentally sustainable.

These regulatory and supervisory frameworks can help to promote greater transparency and accuracy in sustainable finance and reduce the risks associated with greenwashing. By providing clear and consistent frameworks for identifying environmentally sustainable investments, these frameworks can help to ensure that financial institutions and investors have accurate information about the environmental impact of their investments.

Conclusion

In conclusion, financial institutions play a critical role in addressing greenwashing in the financial sector. By developing a clear and consistent approach to sustainable finance, ensuring transparency and accuracy, conducting due diligence, and engaging with stakeholders, financial institutions can help to promote greater sustainability in the financial sector and reduce the risks associated with greenwashing.

To promote greater transparency and accuracy in sustainable finance, financial institutions should also support the development of regulatory and supervisory frameworks that address greenwashing. This includes supporting the development of the EU Taxonomy for Sustainable Finance, the Non-Financial Reporting Directive, the Sustainable Finance Disclosure Regulation, and the Green Bond Standard.

In conclusion, financial institutions play a critical role in addressing greenwashing in the financial sector. By developing a clear and consistent approach to sustainable finance, ensuring transparency and accuracy, conducting due diligence, engaging with stakeholders, supporting regulatory and supervisory frameworks, monitoring and reporting on environmental performance, and collaborating with other stakeholders, financial institutions can help to promote greater sustainability in the financial sector and reduce the risks associated with greenwashing.

References

1. European Banking Authority, ‘ESAs Present Common Understanding of Greenwashing and Warn on Related Risks’ (European Banking Authority, 1 June 2023) <https://www.eba.europa.eu/esas-present-common-understanding-greenwashing-and-warn-related-risks> accessed 3 November 2023. ↑
2. Najah Attig, Mohammad M Rahaman and Samir Trabelsi, ‘Greenwashing and Bank Loan Contracting: Does Environmental Disclosure Quality Matter to Creditors?’ <https://papers.ssrn.com/abstract=3880113> accessed 3 November 2023. ↑
3. Wayne Moodaley and Arnesh Telukdarie, ‘Greenwashing, Sustainability Reporting, and Artificial Intelligence: A Systematic Literature Review’ (2023) 15 Sustainability 1481. ↑
4. European Banking Authority, ‘Progress Report on Greenwashing Monitoring and Supervision’ (EBA 2023) 16 <https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Reports/2023/1055934/EBA%20progress%20report%20on%20greewnwashing.pdf> accessed 3 November 2023; European Insurance and Occupational Pensions Authority, ‘Advice to the European Commission on Greenwashing – Progress Report’ (EIOPA 2023) 157 <https://www.eiopa.europa.eu/system/files/2023-06/EIOPA%20Progress%20Report%20on%20Greenwashing.pdf> accessed 3 November 2023; European Securities and Markets Authority, ‘Progress Report on Greenwashing’ (ESMA 2023) 30 <https://www.esma.europa.eu/sites/default/files/2023-06/ESMA30-1668416927-2498_Progress_Report_ESMA_response_to_COM_RfI_on_greenwashing_risks.pdf> accessed 3 November 2023. ↑