Greenwashing

Actions for Risk and Compliance functions

Actions for Risk and Compliance functions

Greenwashing

As set out in the previous section, a key source of climate risk for investment managers may arise from making “misleading or unsubstantiated claims about environmental performance”²⁶, otherwise known as greenwashing.

Greenwashing is usually seen as a conduct risk (i.e., a deliberate attempt to inflate the green credentials of products) but may also occur inadvertently due to incomplete data and unfamiliar terminology in the sustainable investing landscape. It could arise at both the firm-level (e.g., in disclosures on transition plan progress, or in firm-wide sustainability policy disclosures), or it could arise at the product level (e.g., in fund disclosures).

Regulators are seeking to address greenwashing by (i) improving corporate and financial services firms’ disclosures to provide more decision-useful information to the market²⁷; (ii) addressing shortcomings in the ESG ratings market and in how ESG is integrated into credit ratings²⁸; and (iii) supporting the development of green products and improving product disclosures (see box D for an overview).

Supervisors are also intensifying their focus on funds which promote or target climate characteristics²⁹.

Box D: an overview of regulatory developments in relation to product disclosures to address greenwashing

International: The International Organization of Securities Commissions (IOSCO) published recommendations³⁰ on sustainability-related practices, policies, procedures and disclosures for asset managers in November 2021, with the aim of mitigating greenwashing. IOSCO has also stated that greenwashing will be a key feature of its 2022 sustainable finance workplan³¹.

EU: The Sustainable Finance Disclosures Regulation (SFDR)³², applying to financial market participants and financial advisers, imposes sustainability-related disclosure obligations, particularly on those products that purport to be sustainable in one form or another. Some Member States are considering going further by consulting on additional disclosure rules and guidance on sustainable funds, such as Germany³³.

ESMA has also published guidance³⁴ for supervisors in relation to the supervision of fund documentation and marketing material with the intention of combatting greenwashing.

UK: The FCA published a Dear AFM Chair letter³⁵ in July 2021 setting out its concerns that a number of funds in the UK that claim to be sustainable are unable to evidence these claims. The letter sets out guiding principles on how transparency can be enhanced in the design, delivery and disclosure for these types of funds. The FCA has made it clear that it will supervise the progress against these principles despite there not being formal rules.

The FCA also published a discussion paper³⁶ in November 2021 on a new proposed tiered disclosure regime and accompanying labels for investment products. The discussion paper further highlights the FCA’s commitment to transparency in the area of sustainable investing.

The Competition and Markets Authority published a Green Claims Code³⁷, which provides essential guidance for firms on how to ensure that they make any environmental claims in the right way. In particular, the checklist is a useful tool to help firms meet the relevant guidance. The Code and checklist are not specific to financial services but investment managers will find this useful as a general starting point.

Investment managers should ensure that their disclosures to clients and advisers are clear, fair, and not misleading and that they comply with regulatory requirements and meet supervisory expectations. Doing so should help mitigate conduct risks associated with the transition. For example, disclosures should set out the objectives of funds, the investment strategies used (e.g., exclusions), and the risks and opportunities. If an investment manager is investing in transitioning companies based on a highly active stewardship approach, this must be clear to investors.

Ensuring accurate and compliant disclosures on net zero transition plans, firm-wide policies, emissions, and funds which promote, or target climate characteristics will support the net zero transition, as well as reduce the firm’s liability risk and help to prevent greenwashing. However, a key challenge for investment managers is the quality and quantity of available data.

It will take time for the quality and quantity of corporate disclosures to improve. Nevertheless, regulators have been clear that the absence of data should not prevent financial services firms from integrating climate considerations into risk management, disclosures, and investment decision-making. Investment managers should source and use data on a best-efforts basis, while disclosing limitations. As new data becomes available, investment managers will need to incorporate this and consider how it affects their emissions baselines and targets.

Where investment managers use ESG data and ratings, they should conduct due diligence of vendors and understand the methodologies they use. They should avoid mechanistic reliance on ESG ratings by adding their own layer of analysis on the ESG data, including to ensure that ESG rating methodologies align with investment managers’ investment strategy objectives.

Investment managers will also need to ensure consistency in the approach, underlying data and disclosures across their transition plans, firm-wide policies, and product objectives and disclosures. For example, an investment manager might be overstating its green credentials if it has a firm-wide policy of targeting climate-orientated investments, but only offers a limited range of funds which promote or target climate characteristics, or has a limited exclusions policy. In addition, the FCA requires that a firm explain where its approach to a particular investment strategy, asset class or product is materially different to its overall entity level approach to governance, strategy, or risk management³⁸.

For further information in relation to greenwashing, see Deloitte’s paper, Greenwashing risks in asset management: staying one step ahead.

Actions for Risk and/or Compliance

Support the development of a robust climate data strategy, data governance and target operating model to source varied, current and forward-looking data on climate risk and emissions across own operations and investee companies. Risk and/or Compliance can support the business by reviewing disclosure requirements and the data required for them. They should ensure that there is a data strategy which underpins the firm’s claims and commitments, particularly for asset classes where data is challenging (e.g., emerging markets, real estate and private equity), and that there are controls in place where data is gathered manually.

Ensure the business considers regulators’ concerns when using ESG ratings and data providers. Risk and /or Compliance can also assist with creating procedures in relation to the governance and oversight of data obtained from third parties.

Gain access to all data needed, both from internal and external data sources.

Consider conducting periodic reviews of whether the requirements in firm-wide sustainability data policies are being observed.

Ensure disclosures on the transition plan, firm-wide policies, and products are consistent and meet regulatory requirements and supervisory expectations. Product-level disclosures should be reviewed periodically to ensure ongoing consistency with the developing transition plan and firm-wide policies, and to ensure that exemptions, exceptions and other limitations are clear. Risk and/or Compliance should also consider reviewing disclosures for the same product across jurisdictions to ensure consistency. For example, it may be difficult to market a product as green in one jurisdiction, where it does not meet the relevant criteria in a different jurisdiction.

Leverage existing control frameworks to ensure that there are processes, policies, and controls in place to monitor funds which promote or target climate characteristics across the product lifecycle. This may include looking at wording and claims in pre-contractual documentation to identify potential exaggeration and at post-investment reporting documentation to identify overly technical non-financial performance metrics which might overwhelm retail investors. In doing so, Risk and/or Compliance will need to refer to relevant regulatory rules and expectations and any associated guidance.