Investor eyes shift to European watchdogs in battle against greenwashing

You may have missed a tsunami of regulatory net zero reports earlier this month, but what happened is that the three main European Supervisory Authorities, the EBA, EIOPA and ESMA, each published their so-called progress reports on greenwashing in the financial services and investment space.

The progress reports mark the first part of the ESAs' response to the European Commission's request for input in May 2022 on greenwashing and the implementation, supervision and enforcement of sustainable finance policies aimed at preventing such activities. 

The ESAs' final reports will be published in May of next year, following which the Commission will consider the ESAs' final recommendations, including possible changes to the EU regulatory framework.

In the reports, the ESAs have developed a common high-level understanding of greenwashing "as a practice where 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."

Needless to say, this practice is more often than not misleading to investors.

Discussing the content and impact of the reports with Net Zero Investor, Eve Ellis, a partner in Ropes & Gray’s asset management group specializing in financial services regulation, explained that "as the EBA and EIPOA reports are focused on the banking and insurance and pension sectors, it is ESMA’s report that will be of greatest interest to asset managers."

She pointed out that ESMA’s Report focuses on four specific sectors under ESMA’s remit: investment management, issuers, benchmark administrators and investment service providers. 

"The report looks at the causes of greenwashing and their drivers, and provides high-level insights into monitoring and supervision of greenwashing," Ellis pointed out.

For asset managers specifically, ESMA identifies some areas as being "particularly exposed to greenwashing risks," she continued.

"A fund’s or manager’s engagement with investee companies, namely unsubstantiated or empty engagement strategies, can be neither consistent nor transparent and do not address progress of engagement," Ellis said.

Then there is ESG strategies, policies and credentials, issues relating to unsubstantiated, exaggerated and inconsistent claims in fund documents, followed by ESG governance, such as not ensuring that an ESG policy or ESG implementation is complied with.

There is also the risk of misleading claims on any sustainability impact, such as a lack of commitment and specificity in sustainable characteristics for SFDR funds and overemphasising certain claims.

Fund names, which ESMA highlights as being particularly important for retail investors’ decisions, can also be misleading.

"The causes of greenwashing are identified as the result of multiple inter-related drivers," Ellis explained. 

"Notably, ESMA highlights the current provisions of the SFDR as perceivably driving greenwashing in respect of the lack of clarity around key concepts, such as ‘sustainable investments’ and the DNSH test) as well as the high degree of flexibility and lack of thresholds for Article 9 products."

Labelling regime

The market’s use of the SFDR as a labelling regime is further raised as an urgent issue for investors looking to go green. 

ESMA highlight how participants face challenges across the ‘sustainable investment value chain’ in implementing the necessary governance processes and tools that support high-quality sustainability disclosures and transition efforts. 

"In this context, managers are identified as having difficulties in producing and accessing relevant, high-quality sustainability data," Ellis said.

"Implementation challenges for both managers and for regulators created by the fast-moving regulatory framework are also identified, with ESMA highlighting the need for both participants and regulators to build sustainability expertise."

The report sets out ESMA’s preliminary thinking in terms of remediating greenwashing risks, which includes clarifying key concepts under the SFDR, in particular what qualifies as a 'sustainable investment' and more closely aligning the DNSH tests under the SFDR, the Benchmark Regulation and Taxonomy Regulation.

"Increasing the supply of standardised, audited forward-looking ESG information for the emission reduction targets and transition plans, the application of the CSRD is expected to help deliver this," Ellis said.

Also, "managers across the SIVC have a responsibility to communicate sustainability information in a balanced and substantiated manner, crucial to this will be to ensure that managers implement monitoring systems and reporting regularly on progress."

There is also a need to further clarify due diligence responsibilities of managers in the value chain in order to mitigate unintentional spreading of misleading claims, Ellis said. 

"Interestingly, ESMA identify asset managers offering funds of funds products as having a responsibility here."

Enhancing the reliability and comprehensiveness of sustainability data through further transparency is needed on ESG data methodologies, clarifications on the use and calculation of estimates, external verification and auditing, Ellis concluded.