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Mitigating greenwashing risk in investment management & wealth

Five key areas of challenge

At a glance
 

Deloitte hosted an event on managing greenwashing risk in the Investment Management and Wealth (IMW) industry earlier this year. The objective was to engage the industry in a discussion about the pervasiveness of greenwashing risk. The discussion covered a range of topics, including: incorporating greenwashing risk into risk frameworks; ESG integration into the investment process; ESG data; litigation risk; and the nexus between greenwashing and Consumer Duty.  Panellists and speakers included trade bodies, advisors, regulators, internal Deloitte subject matter experts, and data and ratings providers.

This blog highlights five key issues that firms need to address as they act to mitigate greenwashing risk in 2024 and beyond:

  • the inclusion of greenwashing risk in the existing risk framework;
  • the necessity to take an end-to-end compliance approach;
  • the potential for litigation risk;relationships with third party distributors and advisers; and
  • challenges with implementing the anti-greenwashing rule.

The two immediate starting points for firms are to: (i) consider from a strategic perspective whether they want to continue participating in the sustainable investment products market given the increased regulatory, reputational and litigation risks; and (ii) conduct a risk assessment across their functions and products to determine where they are currently exposed to greenwashing risk.

This blog will be of interest to functions and roles across IMW firms including but not limited to: CROs, CSOs, CCOs, COOs, CTOs, product governance teams, ESG data teams, legal teams and regulatory change teams.

Despite more than two years of debate and discussion on greenwashing risk, the IMW industry across the EU and UK continues to grapple with finding the most effective approach to risk mitigation and control. Many more firms now appreciate the breadth of work required to tackle the risk in all its dimensions. During the coming year, we expect regulatory scrutiny of risk mitigation and controls to intensify further. The FCA’s Sustainability Disclosure Requirements (SDR) final rules are due to be phased in, starting with the anti-greenwashing rule from May 2024, and ESMA’s final greenwashing report and guidelines on use of sustainability terms in fund names are expected to be published in Q2 2024.

Deloitte hosted an event on greenwashing risk on 24 January 2024 for the IMW industry. During the event, industry experts, trade bodies and regulators discussed a range of topics, including ESG risk, ESG integration into the investment process, ESG data, ESG ratings, the role of advisers, Consumer Duty and litigation risk. There was a consensus that greenwashing risk is pervasive across a broad range of firms’ activities and products, and that a collaborative effort across functions is required to tackle it.

This blog highlights five key conclusions from the discussion at the event, which should provide food for thought for firms as they plan their approach to tackling greenwashing risk in the coming year.

1.  There is more than one way of incorporating greenwashing risk into your existing risk framework.

.The speakers and discussants reiterated that there is no one-size-fits-all approach to incorporating greenwashing risk into an existing risk framework. Where and how greenwashing risk features in the risk framework can have a significant impact on the resources dedicated towards mitigation and controls. A key conclusion from the discussion was that firms need to consider the following:

  • whether greenwashing risk should be a separate risk type or classified as a subset of an existing risk type;
  • whether greenwashing risk should be assessed as a cause or a consequence of the crystallisation of other risks; and
  • how important greenwashing risk is in relation to other risk types in the context of a firm’s specific products, net zero statements and overall sustainability ambition.

Once firms have concluded on these points, the next steps are to determine risk appetite, draft the required risk policies, and consider enhancements to existing processes and methodologies e.g. Risk and Control Self Assessments (RCSAs), Key Risk Indicators (KRIs), risk reporting and incident management.

2.  Consider how to implement a compliance framework that captures the end-to-end lifecycle of products.

All the firms we spoke to at the event recognised that greenwashing risk can arise in a plethora of ways across products, and investment and operational activities. The criteria for complying with the FCA’s SDR labels support this perspective as they span governance, resources, stewardship, investment policies and robust evidence‑based sustainability objectives – i.e. the criteria are not based only on misleading or exaggerated language used in documents.

Firms also agreed that whilst remediating existing communications is a good starting point, it is not the full answer. Several firms, however, seemed to be at nascent stages in terms of updating their compliance frameworks.

In our view, firms should ensure that any compliance frameworks capture the end-to-end lifecycle of sustainable products, all aspects of firm-level statements and all possible touch points with investors. At a minimum, the following activities should be included:

  • the use of ESG data or ESG ratings in the design of products;
  • staff education on sustainability-related terminology, consistent use of it, and monitoring of how it is used in day-to-day conversations with clients and consumers;
  • asset allocation and its alignment with sustainable objectives and investment policies;
  • adherence to sustainable objectives over time;
  • whether there is a consistent narrative that can be followed through from initial marketing documents to the sustainability performance reporting documents; and
  • handling of any greenwashing- or sustainabilityrelated queries and complaints.

3.  Have you considered litigation risk and whistleblowing?

Firms that market sustainable products or have made net zero commitments should consider the possibility of being exposed to litigation from clients, civil society or special interest groups (e.g. NGOs or environmental protection groups).  Speakers at the event explained that these risks are an important aspect of greenwashing risk, but that the risks are often overlooked as firms focus on sustainability reporting deadlines.

Globally there is an increasing incidence of greenwashing and sustainability-related legal actions (including class actions in the US) against corporates (including financial services firms), as society shifts towards demanding greater accountability on firms’ contributions to the transition of economies to net zero. It is prudent for legal and risk teams to be abreast of greenwashing-related litigation occurring across the globe, and to consider how internal controls or processes can be enhanced to safeguard against litigation risk.

4. Relationships with third party advisers and distributors can be “make or break”.

There are currently no rules for advisers under the FCA’s SDR, other than the anti-greenwashing rule. There are also no “sustainability preferences” rules in the UK. As such there is no specific guidance for advisers in relation to mitigating greenwashing risk. One speaker noted this as a particular challenge and also emphasised that advisers have very different levels of knowledge on sustainability. The EU does have sustainability preferences rules, however, across both EU and UK there is no guidance on where liability may lie if an adviser greenwashes products (whether inadvertently or otherwise) they are advising on..

Third party advisers and distributors are a key part of the investment value chain. As such asset management firms need to carefully consider how to manage information sharing on sustainability products with them in an area where terminology is unfamiliar and complex, and where each sustainable product is designed in a different way.

At a minimum, asset managers and other firms using third party advisers and distributors should consider the following:

providing periodic training to advisers and distributors on what sustainability terms mean in the context of their specific products;

gathering information from advisers and distributors on whether there are any aspects of their products and documents that clients do not seem to understand; and

ensuring advisers and distributors are always up-to-date on any changes in products and documents as soon as possible.

5.  The anti-greenwashing rule is much more than “clear, fair and not misleading”.

Following the publication of the FCA’s guidance consultation on the SDR’s anti-greenwashing rule, firms have a renewed appreciation that to be clear, fair and not misleading in the context of sustainability is not straightforward. A number of questions were raised at the event about the exact scope of the rule, and about the challenges around the remit under the guidance consultation e.g. the inclusion of images.

Scoping is a key issue. The wording in the anti-greenwashing rule refers to products and services specifically. However, firms may have other statements or communications that refer to sustainability, though not directly in relation to products and services, and will need to decide to what extent formal controls need to apply to these. Based on responses to the consultation, the FCA may provide further clarity in this area. If not, it would be prudent for firms to look at all sustainability-related references through the clear, fair and not misleading lens. It is important to bear in mind that the FCA expects firms that are in scope of the SDR regime but not of the Consumer Duty to keep the Duty's aims in mind nonetheless.

Separately, in the absence of a universal dictionary that explains what sustainability-related terms mean, firms should consider developing an internal taxonomy. Staff will need to be trained on internal taxonomies and have a consistent understanding of what sustainability terms mean in the context of a firm’s specific products, and also ensure they use the right terms in day-to-day conversations.

A final word
 

Ultimately, many firms will be facing big questions around the extent to which they wish to participate in the sustainable investing market, in an environment of increased regulatory, reputational and litigation risk. Firms that approach greenwashing risk with an “end-to-end” view and acknowledge that a joined-up approach is required for mitigation and control, are likely to be the biggest beneficiaries of the demand for sustainable investments.