Greenwashing in Financial Services

Greenwashing restated

Although there is no formal definition, greenwashing is generally understood to be either the practice of making misleading or exaggerated ESG claims; or including information within environmental statements regarding the sustainability of an organisation’s business practices, products or services that overstates green transition achievements (and achieves marketing gains). The practice of greenwashing lowers trust, and can lead to significant follow-on – risks particularly through damage to the organisation’s reputation, but also from civil litigation and administrative penalties. In a recent EU proposal for an EU Green Claims Directive, the legal landscape for what this means for corporates was explained in terms of unfair commercial practices. As yet, the same clarity of definition has not been developed for FSIs, which are omitted from the proposed directive, but the trajectory for such a definition is firming up.
In this context, it is worth emphasising the distinction between greenwashing and criminal activities such as fraud, environmental crime and the laundering of the proceeds thereof. Although such crimes will most likely also be combined with mis-statements of green activity, we should prevent the term ‘greenwashing’ from becoming an umbrella for all kinds of ESG-related non-compliant and criminal activities. As part of any risk assessment, it is vital to clearly understand whether the risks under consideration are reputational or legal (both institutional and individual), or both – and whether potential liabilities arise under civil, administrative or criminal law. We will deal with the specific issues of integrity within the ESG arena – and the potential for related criminal liabilities – in a later article.

Balancing change with prudence

Balancing sustainability ambitions with the reality of real transformation is something that all corporates must deal with to avoid greenwashing. Financial Services Institutions (FSIs) are no exception. Previous greenwashing scandals concern corporates and their marketing efforts towards end-customers, but with increasing regulation – including the EU Taxonomy, NFRD/CSRD, and also the Sustainable Finance Disclosures Regulation (SFDR) – FSIs need to get their own house in order too.
There have already been some reports of NGOs organising themselves to expose FSIs’ potential greenwashing – occasionally setting FSIs up by deliberately obtaining green loans for brown uses, and in doing so exposing flaws in FSIs’ methodology, measurement and internal controls. Whatever the context, throughout transition and implementation of new measures, FSIs need to be watchful that they don’t commit the type of greenwashing infringements they might be scrutinising their customers for. Overstating any element in the information chain, from intent to outcome, will be found out.

Pressure to perform

FSIs, in common with other organisations, are required to make environmental commitments, ensure that they live up to those commitments across what can be quite complex groups, adhere to relevant regulatory standards and evolving EU taxonomy, and ensure the risk management and control environment in place is fit for purpose. Juggling those demands can be challenging, but the sector has a track record of adjusting to changing landscapes – most recently to combat money laundering and address the funding of terrorism. The specific challenge of living up to environmental commitments is the downstream uncertainty inherent to transactions and events with green implications, and the long timeframe of those implications.

The dilemma is how soon to be positive in declaring intentions and progress, while avoiding accusations of greenwashing if the intentions don’t translate into improvements, or the actions are implemented too slowly. The political and social expectations of FSIs are high, but their ability to deliver and lead the way by being ESG exemplars of change could be problematic. Not least because of varying interpretation of the regulations in action, any premature overstatement of ESG achievement is likely to be pounced upon by regulators and NGOs, leading to reputational issues for the institution. Being left behind in this changing scenario will leave banks and their individual leaders in a difficult position, with impaired reputations and the risk of fines or prosecution. Below are challenges we see across many of our FSI customers.

Making commitments

In this unfolding regime, it will be tough to balance ambition with true achievement – particularly given the likely time lag between stating an intention and seeing the fruits of a change programme in pursuit of that goal. Those directing policy within FSIs need to be wary about premature claims and overpromising, however good their intentions are. They also need to navigate the ever-changing landscape of voluntary promises coupled with regulatory impositions that are more codified. Demonstrating compliance with the less-codified commitments is a challenge that may lead to an increasing hesitance, on the part of management, to commit to fresh ESG promises.
There’s a risk that unless perfection in ESG compliance can be achieved, institutions will avoid committing to any progress that doesn’t come to them via regulation. If they hang back until perfection is in sight, they will lag behind the field and risk reputational damage, but if they make commitments too soon, they run the risk of outrunning their internal capability, being uncompetitive, or pricing themselves out of the market through the cost of change. Working collaboratively with others in the market may help to set a common standard for the types of commitments that will and will not be made in the foreseeable future. That can enable some progress towards a level playing field for FSIs in anticipation of future regulatory standards. Those commitments should always be realistic given the organisation’s resources, and have an eye to what will make a material difference to the green transition rather than making overambitious statements for the sake of it.

Consistency within the overall group

Customers have a similar issue whereby most of the group’s activities may meet ESG requirements, but some residual divisions may not pass muster yet provide above-average returns on capital. For a bank that’s publicly stating its positive ESG intentions, having a division or subsidiary that continues to lend to fossil-fuel or other brown industries will not only knock its reputation, but could also lead to sanctions, financial penalties and/or higher capital requirements in the near future. The key is to ensure that policies and exclusions in the investment part of their business are adopted throughout the group, consistent with the lending activities. As an FSI, pleasing all different stakeholders at the same time will be impossible, but providing a consistent visible transitional approach – and adhering to it – should be a realistic goal.

Interpreting the EU taxonomy

Too strict an interpretation of how green improvements should be measured, managed and reported on could lead to a complete paralysis of progress, albeit while avoiding any instances of greenwashing. Too broad an interpretation of the same may lead to far more positive and uplifting stories of greening, but at the risk that some or all of the story is found out later to be unsubstantiated or materially overstated. It’s a question of balance.

The control environment

Establishing and policing an appropriate control environment that’s in line with policies set at the strategic level is a key challenge. Leadership teams will need to agree the acceptable level of risk for the business, and build the control mechanisms both around those tolerances and to recognise that it is likely there will be insufficient data to manage risk without making significant assumptions along the way. When it comes to control over lending – for example, ensuring the proper certification of green mortgage borrowers – the important factor is vigilance, to avoid outcomes where green credentials are overstated. Getting the control environment right is a thorough exercise full of nuances, and is one change that can’t be rushed.

Our perspective – four tips to get started

When it comes to averting claims of greenwashing, every FSI will find itself in a situation that’s unique to its book of business, mix of stakeholders, and management ethos. Despite those nuances, there are several patterns of best practice emerging that all FSIs would do well to adopt.

1. Put in the effort now. The current uncertainty around standards and methodology could lead to some organisations holding fire on appropriate steps to clamp down on greenwashing now, in the belief that some of those steps might be misdirected. Any temptation to hold back and wait until there’s more guidance leads to time wasted. Experience from other regulatory-driven transitions such as KYC, AML/FC have made FSIs understandably risk averse, but that inaction carries its own risk. The sooner organisations act and ‘learn by doing’, the better. Sarah Breedan, of the Bank of England, put it best when she said that “uncertainty over climate policy cannot be an excuse for inaction.” It is also key to involve audit and legal expertise as early as possible, to get those insights baked into the change process.
2. Work collaboratively both internally and across peer groups in the market. There are many moving parts within the internal administrative machinery of a financial institution. Finance, Risk, Sustainability, Audit, Legal and the business all have a role to play. In the most successful examples, the FSI’s Finance department orchestrates these stakeholders in all aspects of ESG management and reporting. Their experience in scrutinising the source, quality and substance of other reported data is invaluable, and is transferable to non-financial areas that those with an explicit risk management remit – and those with responsibility for sustainability – will be looking to bring up to the standard of financial reporting diligence. Externally, there are ways of consulting with others in the market towards agreed best practice in the absence of pertinent legislation and standards, and to achieve a common understanding of what the sector can do to make a material difference, rather than simple competitive point-scoring through claims.
3. Accept and manage risk. FSIs need to establish acceptable levels of risk, and acknowledge that they may have imperfect ESG data to report on. Seeking the advice of internal audit here is incredibly valuable, and helps establish the appropriate internal policies to indicate where the highest risks of greenwashing are, and means to apply resources to mitigate those risks. Some of those risks are likely to be new territory for most organisations, but the best practice is to conduct as thorough a risk assessment as possible as soon as is practicable.
4. Be transparent. Here, the phrase ‘warts and all’ comes to mind. It is better for FSIs to be straightforward and open about their pace of transition, and to disclose their shortcomings rather than overstate achievements. This buys credibility, and conveys a confidence in their ability to make progress and remedy those shortcomings in the longer term. Communicating that the organisation has nothing to hide builds stakeholder trust, and is also more likely to help strike the best relationship with supervisory authorities.

To discuss any of the themes raised in this article, or to arrange an assessment of your current ESG credentials, contact us below.