- Greenwashing accusations highlight tensions between consumer protection and environmental credibility
- Questions are being asked about whether regulators will punish investors for ‘unintentional’ greenwashing
- EU laws already exist to prevent greenwashing but more are likely to be introduced
The Oxford English Dictionary (OED) defines greenwashing as: “(a) To mislead (the public, public concern, etc) by falsely representing a person, company, product, etc as being environmentally responsible; (b) to misrepresent (a company, its operations, etc) as environmentally responsible”.
Although financial markets rely more on lawyers than lexicographers to understand how regulatory terms are defined, the OED hits on the first dilemma for those trying to navigate ever-strengthening greenwashing rules, and those trying to enforce them: is greenwashing about misleading clients, or it is about making questionable environmental statements?
While the two often overlap, they are not mutually inclusive.
Take the recurring media headlines expressing outrage that some climate funds contain oil stocks. In an article last year, the leading UK taboid, the Daily Mail, accused the managers selling these kind of products of “deceit”, describing fossil fuel investments as ones “that most green investors would otherwise run a mile from”.
But it is widely acknowledged in green finance that meeting the goals of the Paris Agreement will involve owning, and influencing, the economy’s big polluters. The theory of change underpinning these climate funds may be legitimate, even if clients do not expect their money to be used this way.
Jakob Thomä, executive director of think tank 2° Investing Initiative (2Dii), says that this tension is not new.
“In finance we always feel like we’re inventing something, but greenwashing has existed as a concept for decades in the corporate world, and there are already rules and definitions,” he explains, pointing to the European Union’s 2005 Unfair Commercial Practices Directive (UCPD) which, among other things, seeks to protect consumers against miss-selling.
Although not strictly environmental in its focus, the UCPD identifies two ways in which greenwashing can occur: by being untruthful, or by misleading even if the information is accurate.
“The problem is that it’s easier to deceive in finance than in other industries…the ambiguity of the language is much more problematic”
The EU says that “traders must present their green claims in a clear, specific, accurate and unambiguous manner” and the directive bans communication that’s “likely to deceive the average consumer”, regardless of whether it is technically accurate or not.
“The problem is that it’s easier to deceive in finance than in other industries, because regular people don’t understand finance,” Thomä explains. “They don’t get the complexity of things like sustainability improvement loans and low-carbon benchmarks, so the ambiguity of the language is much more problematic.”
In a 2020 survey of 500 German retail investors, carried out by 2Dii, around 90% thought the ‘green’ in green bonds should refer to the companies’ environmental performance, not the way they spend specific proceeds. Nearly 50% of respondents said a green bond did not have to be 100% green, but should have an explicit goal of becoming greener or 100% green (see figure).
Divestment thresholds are another big driver of misalignment between expectations and reality, because, while they tend to attract the clients with the strongest views, they are rarely able to exclude 100% of the activity they promise to avoid.
For example, most ‘ex-fossil fuel’ funds have a threshold for exclusion, meaning that firms generating a small proportion of their revenues from oil, gas or coal can still make it into the portfolio. And it is not just low-carbon strategies that can be slippery: sustainability funds that claim to exclude animal testing commonly waive those rules for medical research, on the grounds that it is good for humanity. And those offering to eliminate a client’s exposure to the sale of alcohol are unlikely to screen out, say, airlines that sell booze on flights.
2Dii found that, as a result, many retail investors would feel misled by these strategies.
As sustainability-based methodologies get more sophisticated, especially on the climate transition side, they will inevitably move further away from the expectations of the everyday investor. With consumer protection agencies, rather than environmental specialists, currently driving greenwashing enforcement in Europe, this is likely to result in a growing body of litigation on the retail side, but minimal interference with institutional investors.
Line between intentional and accidental
Another big question for regulators and asset managers when it comes to greenwashing is whether the intention matters.
In January, Europe’s three financial supervisory bodies, known collectively as the ESAs, closed a consultation on greenwashing that will help them develop definitions, assess existing legislation and work out what should happen next on the topic.
In the document, which contains exploratory statements rather than the ESAs’ final position, the supervisors suggest that “greenwashing can be either intentional or unintentional”.
Julia Vergauwen, an ESG investment specialist at London-based law firm Linklaters, says that the inclusion of references to unintentional greenwashing in the call for evidence is “surprising” and “shows how much the concept of greenwashing is changing”.
There is speculation that it could mean penalties for funds that fail to meet their stated environmental targets, or institutions that define sustainability differently from the European Commission.
“Intentional greenwashing should obviously not be permitted, but if regulators start threatening enforcement against unintentional greenwashing, it could paralyse the industry,” says Vergauwen. She believes that current regulatory uncertainty in Europe makes it challenging for asset managers to know what is considered credible when it comes to sustainable finance.
Lack of definition
That uncertainty centres on the EU’s Sustainable Finance Disclosure Regulation (SFDR), which is a set of new rules seeking to reduce greenwashing by making financial institutions explain how they approach environmental and social issues in investment strategies. But the EU has so far refused to provide a clear definition of what sustainable investment is under the regulation, leaving investors confused about what they are being benchmarked against.
“The debate about greenwashing is becoming acrimonious because asset managers are worried that, in a context in which we do not have a clear definition of sustainability, they might make mistakes in good faith,” says Jérôme Reboul, a managing director in the policy and international affairs directorate of French regulator AMF, which is responsible for enforcing the SFDR and other anti-greenwashing rules in France. “And, in that context, so might we.”
Reboul says the real question is whether regulators like AMF “are in a position to provide certainty to asset managers on claims that we think are not false and misleading”.
“Intentional greenwashing should obviously not be permitted, but if regulators start threatening enforcement against unintentional greenwashing, it could paralyse the industry”
“We should be able to take enforcement actions against claims that are demonstrably false and misleading. In order to do that, we need to have certainty in the first place on whether a statement is false and misleading.”
AMF wrote to the European Commission earlier this year, urging it to introduce a robust definition of sustainable investment into the SFDR. In April, the Commission published an official Q&A on SFDR, saying it was up to financial institutions to decide how they were defining sustainable investment themselves – and that the SFDR simply required transparency about those definitions. However, it has also said it will consider AMF’s request when it undertakes its “comprehensive assessment” of the regulation over the next year, in which it is expected to explore the regulation’s usability, legal certainty and role in mitigating greenwashing.
But Reboul says that, even with clear definitions, the concept of accidental greenwashing will be challenging.
“A national competent authority should not have to prove that a false and misleading market practice was also done on purpose,” Reboul continues. “From a legal perspective, that would be very difficult.”
“But insisting that greenwashing is intrinsically intentional would require us to prove, on top of the fact that a claim is false and misleading, that it was also done on purpose,” Reboul continues. “And, from a legal perspective, that would be very difficult.”
LinkLaters’ Vergauwen says it is important that all regulators clarify that “they will only enforce greenwashing when it is intentional or it stems from gross negligence”.
“Where the manager has done its best, considering the current uncertainties, it wouldn’t be right to take it beyond that,” she says, adding that being too tough will discourage innovation and ambition.
Take net-zero pledges: most financial institutions know they can only meet their climate targets if there is major political, fiscal, technological and scientific progress over the next decade, most of which are beyond their control. At the moment, that doesn’t stop hundreds of them from identifying as ‘net-zero investors’ and creating momentum in the market. But if regulators move to punish entities that make big green commitments and then not meet them, that ‘net-zero’ label may fall out of favour with even the most ambitious market participants.
But Thomä says that “sustainable finance is not a legal-free area where all that matters is whether your heart is in the right place”, and that enforcement should not stop any ambitious action. “Greenwashing relates to the credibility of how you talk about what you do, so just don’t tell people you’re doing something transformational when it is unclear whether you are or not,” he argues.
Under the EU’s UCPD, sustainability-related claims must be based on “verifiable” information. This requirement, aimed primarily at corporates, will be more challenging for investor strategies – especially public equities and bond portfolios with heavy exposure to secondary markets – and investors are likely to struggle to verify their environmental and social impacts in the way that firms operating in the real economy can.
But with most greenwashing rules focused on safeguarding retail investors, big ideas and innovations should still be possible on the institutional side, where investors are qualified to make more sophisticated judgements about their managers’ claims.
“All these things are pretty new, so institutions shouldn’t be fined billions of dollars if they make an honest mistake,” says Thomä. “But if you don’t take greenwashing enforcement seriously, you amplify the idea that sustainable finance is just an experiment.”
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