We are all aware of the remarkable growth in funds under management in sustainability products and markets over the past six to seven years. At the same time, the concerns of market participants, institutions and retail investors about greenwashing risks have increased.
The European Union has actively developed and implemented a number of measures to ensure a trusted environment for sustainable investments, protecting investors and building market integrity. Nevertheless, allegations of greenwashing against both financial and non-financial entities have grown, drawing increasing attention from market regulators.
The European Commission requested “input related to greenwashing risks and the supervision of sustainable finance policies” to the three European Supervisory Authorities (ESA’s) in May 2022. In response, the European Securities and Markets Authority (ESMA) will publish a final report in May 2024, which will include regulatory recommendations for supervisory powers, resources, and actions to address greenwashing risks.
In its preliminary report, the ESMA outlined risks and possible remedial actions for issuers, investment managers, benchmarks, and investment service providers - the entities identified as most at risk to greenwashing. The report highlights that the reliability of sustainability data would be improved by greater transparency on ESG data methodologies, more reliable estimate calculations, and external audit and supervision, allowing issuers, traders and investors to make better-informed decisions. The ESMA report also identifies several inter-related greenwashing risks:
- Misuse of Sustainable Finance Disclosures Regulation (SFDR) as a labelling regime;
- Misleading investment information based on omission, ambiguity, exaggeration, cherry-picking, and empty claims about all aspects of a product or issue’s sustainability profile, including: ESG strategy, ESG governance and resources, ESG performance metrics, and sustainability impact.
- The prevalence of greenwashing risks in forward-looking information and forecasts of future ESG performance.
Effective 1 January, 2024, the European Union’s Corporate Sustainability Reporting Directive (CSRD) will require not only large companies but mid- and small-sized companies to start to collect additional data and information to be published in their 2025 annual reports and sustainability disclosures.
From 2025, large companies of 500 employees or more with listed securities on EU-regulated markets will be required to report under CSRD for the current financial year, with all other companies brought under the regulation by 2028. Under CSRD, companies are required to increase the focus of disclosure and reporting to targets and forward-looking information.
Meanwhile in the US, federal climate disclosure requirements should be final in 2024 and effective by 2026, likely enhancing the development of the US sustainable finance market as public companies are held to a higher standard of climate data transparency by the Securities and Exchange Commission (SEC). Already in California, over 5,000 large public and private companies are now required under two new climate related laws to disclose Scope 1-3 emissions data, while over 10,000 companies have to report on their climate-related financial risks While California’s regulatory agencies face challenges to implementation, if a critical mass of companies are required to report under California’s rules, then the SEC’s rules could prove more acceptable. However, any further delay in the SEC bringing forward its own set of improved regulations could delay some companies from issuance while they wait for regulatory clarity. Nevertheless, the US Dollar ESG market remains on track to become more defined, credible and transparent.
As both new regulatory regimes establish themselves, companies will understand the importance of establishing a strong framework for sustainable finance of detailed methodologies, transition plans and reporting schemes, rather than rushing headlong into ESG securities issuance. Investors will become increasingly intolerant of greenwashing, looking for specific metrics to prove ESG credibility and assess risks, opportunities, value and quality.