Modern businesses are under pressure from all directions when it comes to sustainability targets. There are regulatory requirements, investor pressures, customer expectations, and increased NGO and media focus. This has a significant impact on competition and can incentivise firms to exaggerate their ESG credentials. It can be due to limited data, leading to a misleading picture of sustainability activity, or changes in the company structure, such as appointing a head of sustainability with few related responsibilities. As a result, greenwashing is on the rise.
To address this, the European Commission called for input on greenwashing and mandated the European Supervisory Authorities – European Banking Authority (EBA), European Securities and Markets Authority (ESMA) and European Insurance and Occupational Pensions Authority (EIOPA) – to report on the key risks across the financial sector. The final report is due next year, but the EBA's progress report on greenwashing monitoring and supervision highlights the demand for greater accountability and the areas most susceptible.
What are the risks of greenwashing?
Greenwashing is a significant risk for banks and customers alike, and one that needs to be taken seriously. For customers or shareholders, there’s a risk of mis-selling, which can lead to negative consumer outcomes. For banks, the EBA sees reputational, operational and strategic risks as the biggest concern, including legal risks, liability claims or fines. Liquidity or funding risks are currently the least affected but could ultimately reduce access to market funding or limit the ability to issue green bonds (due to lack of trust or reputational damage).
Banks need to make sure they're not making misleading claims about their ESG activities. This includes updates on the firm’s approach, its real-world impact and future commitments. For example, claims may be misleading if sustainability objectives aren’t embedded in the firm’s strategy or business activities, or if they have limited positive impact on sustainability. Planned activities can be misleading if they "cannot be reasonably ascertained in the near term, and which rely on medium or long-term plans".
A wider definition of greenwashing
With a broad range of approaches to tackle greenwashing – including the EU Taxonomy, Sustainable Finance Disclosure Regulation (SFDR) and the EBA’s roadmap on sustainable finance – there are a raft of definitions available for greenwashing. The EBA found that these definitions are potentially too narrow and focus on products, to the exclusion of activities and pledged activities by firms.
From a starting point the EBA understands greenwashing to be a: “… a practice whereby sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services. This practice may be misleading to consumers, investors, or other market participants.”
Information can be misleading for a range of reasons. It may be outright false, or include mislabeling or misclassification. Or it may simply be inconsistent. Firms can also mislead by omitting key facts, making vague statements, or oversimplifying descriptions. There are also misleading actions to consider, for example, specifically targeting non-sustainable products for a customer segment that has indicated a sustainable preference.
These actions can be intentional or unintentional, within or outside the EU’s regulatory framework, and apply to entities, financial products, instruments and services. To put that in context, an entity can greenwash by making unsubstantiated claims about its sustainability strategy or performance. Similarly, services can be greenwashed by not appropriately factoring sustainability preferences into financial advice.
This is a much bolder interpretation of greenwashing, which has traditionally focused on products and selling. The EBA is also keen to highlight that greenwashing can occur at any point in the product life cycle, and also be carried out by third parties such as ESG ratings providers.
Greenwashing trends and most susceptible areas
Drawing on data from RepRisk ESG Data Science, the EBA highlighted that greenwashing has been on the rise since 2012, across all three factors of environmental, social and governance. Alongside this, greenwashing has received greater focus and accountability has increased. One reason for the rise could be greater awareness and regulation, making it easier to spot. It could also be due to greater demand for sustainable products and services, putting greater pressure on firms to keep pace.
The EBA also conducted a survey of market participants, and found that greenwashing was most prevalent in pledges for future ESG performance. This included key targets, transition plans and net zero commitments. Respondents also felt that this had a high impact on the general public or those who could be affected by greenwashing claims.
Other susceptible areas include the following:
- Stakeholder engagement
- ESG performance including metrics to assess impact
- ESG-related qualifications, certificates or labels
Tackling greenwashing risks
With a range of regulations addressing greenwashing, directly or indirectly, awareness of the issue is growing, and firms are increasingly being held accountable. Firms across the financial sector will need to put better provision in place to prevent triggering or spreading, deliberate or inadvertent greenwashing.
- Training to improve awareness at every level of the firm
- Improving accountability by identifying the senior management functions and governance forums responsible for escalating and remediating greenwashing concerns
- Creating internal policies and controls to mitigating greenwashing risks
- Staying up to date with market practice, and regulatory and stakeholder expectations to inform good practice
- Making clear, accurate and comprehensive disclosures that avoid jargon and ill-defined terminology
- Establishing clear methodologies and data to support disclosures, including any known limitations or improvement plans
- Seeking third-party assurance over controls, policies and procedures
Taking action at every stage of the business life cycle – from organisational strategy and commitments, to product design, to target market to advisory services – will help firms meet their ESG obligations and targets.
For more information insight and guidance on greenwashing risks, get in touch with Rashim Arora.