ESMA, EBA & EIOPA final greenwashing reports – what stood out?

At a glance
 

This summer, ESMA, EBA and EIOPA published reports analysing greenwashing risk across the investment management, banking and insurance industries, and providing recommendations to both supervisors and financial services firms for tackling it.

The reports contain analysis that in several respects will be familiar to firms. For example, they re-iterate prior observations from the three European Supervisory Authorities (ESAs) about the pervasiveness of greenwashing risk and how to address it. The reports also emphasise some, by now, standard key messages about the importance of having robust governance in place, using clear and precise language to describe green products, due diligence on ESG data, and routine monitoring.

Importantly, however, the reports also include new insights on greenwashing. In this note, we highlight several points that stood out to us as novel, and which will help firms develop further their strategy for addressing greenwashing risk. In particular:

• All three ESAs emphasise existing regulations that set standards for greenwashing and provide a basis for supervision and, ultimately, enforcement. Although greenwashing-specific regulations (and supervision based on them) are relatively nascent, there are established regulations which supervisors or other authorities can leverage. This should prompt firms to consider whether they need to accelerate their plans to tackle greenwashing risk.
• Regulators have an increased interest in using ‘SupTech’ tools to identify greenwashing risk. Firms should consider whether they can use similar tools to assess whether their communications meet regulatory requirements.
• The threat of greenwashing-related litigation risk has increased as a key concern for supervisors. Legal, compliance, risk and sustainability teams can assess greenwashing cases that have been taken to court to deepen their understanding of how their firm is exposed to the risk.
• ESMA is considering the development of a quantitative risk indicator for supervising greenwashing risk, which could be used across sectors. There are no details of what the indicator would look like. Based on the areas of concern ESMA has set out, it could try to measure the robustness of governance, controls and due diligence on ESG data, amongst other things.

The recommendations in the reports are not legally binding. The ESAs are now considering the best way to incorporate the recommendations into legislation. However, for firms developing risk mitigation capabilities, the reports are an essential read.

This note will be of particular interest for members of staff across investment management, banking and insurance firms who have responsibility for greenwashing risk or are involved in overseeing green claims made at the firm or product level, including CSOs, CROs, CCOs, CIOs, product governance leads, ESG data teams and legal teams.
 

EU response to greenwashing
 

In June 2024, the ESAs – ESMA, EBA and EIOPA – published three ‘final reports’ on greenwashing (see here: ESMA, EBA and EIOPA), each pertaining to their respective sectors. These reports followed progress reports published in June 2023 (see here: ESMA, EBA and EIOPA) and were written in response to a request by the European Commission to gather information on how greenwashing risk manifests in financial services.

The ESAs’ state a shared description of greenwashing as: ‘a practice whereby 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 market participants.’

The final reports investigate the role of supervision in mitigating greenwashing risk and provide recommendations to both supervisors and financial services firms for tackling it.

The recommendations are not legally binding. The ESAs indicate in the reports that they will continue to consider how to incorporate their recommendations into legislation. Having said that, in our view, given the detailed analysis provided in the reports, firms looking to develop their capabilities for mitigating greenwashing risk will find that the reports serve as a comprehensive and essential guide. For example, the reports reiterate several areas of importance for mitigating greenwashing risk, such as enhanced governance, robust controls and due diligence. As such, at the very least the reports serve as a useful reference for a gap analysis of existing greenwashing-related controls.

This note explores several points from the reports which stood out to us more novel, and which will help firms develop further their strategy for addressing greenwashing risk.
 

Firms should not focus only on future regulatory requirements. Greenwashing risk can be dealt with by supervisors under existing regulation.
 

Whilst addressing greenwashing risk, firms should keep in mind that it is already addressed by existing regulations. Supervisors do not have to wait for greenwashing specific regulations to be able to take action if they detect greenwashing. The ESMA report details in an Annex a plethora of existing regulations (and specific provisions) that investment management firms can be supervised on in relation to greenwashing. Similarly, the EBA report offers a list of existing relevant regulations, including the Unfair Commercial Practices Directive, the Mortgage Credit Directive and the Consumer Credit Directives. The EIOPA report refers to the Sustainable Finance Disclosures Regulation, the Insurance Distribution Directive and the Institutions for Occupational Retirement Provisions II Directive as being relevant.

Firms will be familiar in general with the provisions in the existing regulations but may not have considered fully greenwashing risk in this context. If firms have not yet assessed how these regulations apply to greenwashing, they need to do so without delay and enhance their governance, controls and processes where they identify gaps.

It is instructive that, to date, the greenwashing related regulatory cases against financial services firms (that are in the public domain) have been based on a range of existing regulations, not specific to sustainability or greenwashing. This reinforces our view that understanding the wider regulatory landscape is critical if firms are to build effective anti greenwashing controls.
 

SupTech is being deployed to tackle greenwashing risk. Firms should prepare accordingly.
 

The ESMA and EIOPA reports mention regulators’ interest in developing technology-based supervision tools for greenwashing. ESMA has already been experimenting and published a study (TRV report – ESG names and claims in the fund industry) in October 2023. In the report, it set out results of a scan of ESG related terms in 36,000 fund documents done with Natural Language Processing (NLP). ESMA is now creating a large database of sustainability-related terms to further its use of NLP. ESMA and EIOPA are particularly interested in using NLP for sustainability disclosures.

In the absence of a universal taxonomy, different firms may interpret the same terms in different ways. NLP will enable supervisors to undertake a granular check of disclosures. Firms should consider creating an internal taxonomy and ensure they have a clear understanding of what sustainability-related terms mean for their products and why they have been used in specific disclosures. Whilst the EU Taxonomy sets out which economic activities are sustainable it does not provide universal definitions for basic sustainability-related terms such as “environment”, “climate”, “social” etc. Demonstrating meaningful and consistent use of these terms is a challenge for firms, and this is where internal taxonomies will help.

Separately, firms could prepare for SupTech supervision by accelerating their own adoption of AI and pre-emptively using it to satisfy themselves that their sustainability-related language is consistent across all their communications.

Whilst the EBA did not mention SupTech in its report, it seems likely the EBA will also use SupTech to assess disclosures and other net-zero related information on banks’ websites.
 

Litigation risk is on the rise and is increasingly crystallising in financial consequences for firms.
 

The EBA report emphasises that increasing climate-related litigation against firms is an emerging trend, particularly in relation to greenwashing and breach of Directors’ duties. The report goes on to say that courts in many jurisdictions are increasingly open to ruling in favour of shareholders and NGOs. The European Central Bank has similarly highlighted the importance of climate- and environmental-related litigation for the banking sector. Whilst not specifically mentioned in the ESMA and EIOPA reports, litigation risk is clearly relevant across all three sectors. We have previously published analysis on climate litigation risk for insurers.

Whilst reputational risk is an expected consequence of litigation risk, the EBA report references an LSE study that states that climate litigation filings or unfavourable rulings have a detrimental impact on stock price. On average, the detriment was found to be – 0.41%. The study covered 108 climate-related lawsuits against US and European-listed firms.

One important approach to mitigating litigation risk is to ensure that legal, risk, compliance and sustainability teams understand the firm’s sustainability ambition, products, language and risk exposure. Those teams will also benefit from having knowledge of the key aggravators of this risk and on exactly what basis cases have been mounted in jurisdictions where the firm operates, and also globally. There are nuanced differences in the basis for such cases e.g., in some jurisdictions greenwashing cases have been mounted on accusations of firms violating competition law.
 

ESMA is developing a quantitative risk indicator to supervise greenwashing.
 

ESMA states in its report that it is working on creating a quantitative risk indicator for greenwashing supervision, which could be used beyond the funds industry. Currently, no details have been provided on what this indicator may look like. Given the ESAs’ emphasis on robust governance, controls, due diligence on ESG data, technical expertise, risk-based prioritisation and retail investor education, the indicator could try to capture the maturity of firms in these areas.

Conclusion
 

The greenwashing journey for financial services continues. Three reports including several recommendations to both firms and supervisors indicate the importance of the subject to the ESAs. Whilst there has been a build-up of regulatory initiatives and industry discussion on greenwashing over the last few years, now is when the story really starts. There has been a lack of supervisory censure on financial services firms in the EU and UK. In our view, this is because regulators have been busy working with industry to get the regulations – such as the EU SFDR and UK anti-greenwashing rule – in place. With more regulatory clarity now available, we expect focus to turn towards active supervision.