The European Supervisory Authorities (ESAs) have published their progress reports on greenwashing in the financial sector, putting forward a high-level understanding of greenwashing applicable to market participants across their respective remits – banking, insurance and pensions and financial markets.
The ESAs consist of the European Banking Authority, European Insurance and Occupational Pensions Authority and European Securities and Markets Authority.
As part of their progress report, the ESAs define 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. This practice may be misleading to consumers, investors, or other market participants.
The ESAs also highlight that sustainability-related misleading claims can occur and spread intentionally or unintentionally and in relation to entities and products that are either within or outside the remit of the EU regulatory framework.
The National Competent Authorities (NCAs) and the ESAs are, therefore, working to meet expectations from stakeholders to ensure consumer and investor protection, support market integrity and maintain a trusted environment for sustainable finance. Given the integrated nature of the financial system, the ESAs work in a coordinated manner to address greenwashing.
ESMA progress report
The European Securities and Markets Authority (ESMA) conducted a comprehensive assessment to identify areas within the sustainable investment value chain (SIVC) that are most susceptible to greenwashing risks. The aim of the assessment is to assist market participants in preventing and mitigating greenwashing practices, while also aiding ESMA and National Competent Authorities (NCAs) in prioritising supervisory actions and regulatory interventions.
The findings reveal that misleading claims associated with greenwashing can span across all critical aspects of a product or entity’s sustainability profile, encompassing:
- Sustainability strategy
- Targets and metrics
- Impact claims
The report provides sector-specific evaluations for key sectors falling under ESMA’s purview, including issuers, investment managers, benchmark administrators, and investment service providers.
The causes of greenwashing
Greenwashing arises from a combination of factors. Market participants throughout the SIVC encounter challenges in implementing robust governance processes and tools to enable accurate and high-quality sustainability disclosures and transition efforts. Additionally, accessing relevant and reliable sustainability data proves to be a significant hurdle. The rapidly evolving regulatory landscape has also presented challenges for both market participants and NCAs, underscoring the importance of cultivating expertise in sustainability matters.
One aspect explored in ESMA’s report relates to the limitations of using ESG controversies as indicators of greenwashing-related financial risks. Entities may become entangled in greenwashing controversies to varying degrees, which subsequently impacts their financial risks. Sometimes, an entity’s involvement is reflective of systemic issues within an entire sector or comes from differences in environmental protection policies across countries.
As such, these incidents can have reputational impacts on firms operating within the affected sector or country. Unfortunately, such nuances may not be immediately discernible through financial data related to controversies, calling for additional filtering to understand the potential reputational and financial implications for these firms.
The challenge of indirect involvement poses a dilemma for the financial sector, as financial institutions often provide funding to firms involved in controversies beyond their direct control. Similarly, controversies may be linked to a firm’s own operations or its broader value chain. The presence of large group structures and numerous subsidiaries further complicates a firm’s ability to gain a comprehensive overview of its operations. Nevertheless, firms are increasingly expected to assume responsibility throughout their value chains.
Preliminary remediation actions
To mitigate greenwashing risks, ESMA argues market participants across the SIVC have to live up to their responsibility to make substantiated claims and communicate on sustainability in a balanced manner.
The quality of sustainability disclosures to retail investors needs to be improved, including by establishing a reliable and well-designed labelling scheme for financial products. Finally, the regulatory framework needs to gain maturity, key concepts need to be clarified and sustainability impact or engagement better integrated.
The ESAs will publish final greenwashing reports in May 2024 and will consider final recommendations, including on possible changes to the EU regulatory framework.
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