Greenwashing, greenbleaching and ESMA’s Progress Report

The UK’s Financial Conduct Authority (FCA) has delayed the implementation of the Sustainability Disclosure Requirements (SDR) policy statement until Q4 2023, providing some relief for UK-based asset managers who have been scrambling to assess and mitigate their greenwashing risk.

But UK firms shouldn’t get too comfortable. ESMA, the European regulator, recently issued a warning to funds that can’t substantiate their sustainability claims. Anyone marketing funds in the EU via National Private Placement Regimes (NPPR) is under ESMA’s purview and should pay close attention, regardless of their location.

In this post, we’ll explore the most common greenwashing (and greenbleaching) pitfalls, including the best approach to ensure compliance with applicable regulations.

ESMA’s Greenwashing Progress Report

On 1 June 2023, the European Securities and Markets Authority (ESMA) released a “progress report on greenwashing.” The report aims to support a broader understanding of what is meant by the term “greenwashing” in a regulatory sense.

Greenwashing is defined by ESMA 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.” The concern from regulators has long been that misleading marketing could unduly influence consumers, investors and other market participants.

While this message applies directly to asset managers in the EU, it will also impact managers across the globe. Anyone marketing funds in Europe should pay close attention to avoid practices around sustainability  that ESMA might see as greenwashing.

ESMA is set to issue a final paper on the subject in May 2024, this one a set of guidelines demonstrating how firms can substantiate claims and avoid greenwashing penalties. In the meantime, the June 2023 paper is the best available guide to greenwashing risk published by a regulator.

What contributes to greenwashing risk?

ESMA’s paper has created something of a stir, in part because it acknowledges that SFDR has contributed to greenwashing risk in a roundabout way. SFDR, arguably the most complex piece of European funds regulation to date, was designed, amongst other things, to reduce the risk of greenwashing through enhanced disclosures.

But as anyone who has seen a typical 40–50-page ESG or Sustainability report can tell you, not all the claims made in them are likely to be fully substantiated. Asset managers can easily fall foul of the exacting and comprehensive standards set out in the ESMA paper. “Cherry-picking, omission, ambiguity, empty claims (including exaggeration), misleading use of ESG terminology such as naming, and irrelevance” are among the top misleading qualities ESMA intends to eliminate.

This challenge is not solely for the asset management industry. In their recent paper, the European Banking Authority highlighted the risk of EU banks and other financial institutions generating misleading information about their sustainability efforts. The most common problem is financial institutions promoting support for sustainable initiatives while failing to disclose support for projects linked to “fossil fuels” and “deforestation” for example.

On the one hand, ESMA’s report provides tools and guidance that will help asset managers shore up their reporting and avoid regulatory penalties. On the other, it forms a regulatory foundation for supervisory greenwashing reviews, applicable worldwide.

The opposite end of the spectrum: greenbleaching

While greenwashing is under the microscope, an opposing practice known as “greenbleaching” has also emerged as a trend that’s troubling regulators. This term is used to describe funds that—for example—designate as Article 6 even though they incorporate ESG factors in their investment process. Managers may inadvertently engage in greenbleaching as they have genuine concerns about their ability to gather the necessary data required for Article 8.

While regulators are currently focused on how to combat greenwashing, greenbleaching is also in breach of SFDR according to the progress report. Any reporting practices that lean in this direction could attract regulatory attention.

Asset managers must find a ‘Goldilocks Zone’ in their promotions, neither too hot (exaggerated ESG claims) nor too cold (understated ESG claims), to reach a balance point.

How to mitigate greenwashing risk

The most robust defence against greenwashing risk is setting specific metrics, measuring them, and reporting them as evidence to validate your sustainability claims. The best claim to make is one based on specific, measurable evidence you can track and report on progress periodically to investors. Claims that cannot be substantiated with evidence are best omitted.

IQ-EQ has spent months performing thorough greenwashing reviews for our clients to identify the gaps between ESG claims made in promotional materials and the policies and procedures that document how ESG is integrated into investment decisions and firm operations to support their claims. These gaps can occur for various reasons, including market and peer practices; lack of communication between front- and back-office teams or between the Compliance Director and the ESG Director; time pressures at key phases such as fundraising; and general lack of oversight.

Our team specialises in providing one coherent approach on all ESG-related matters, including closing any gaps that might raise a red flag for regulators. Contact us today to gain access to our world-class support.