Sustainability Assembled
Greenwashing risk
The second quarter of 2024 focuses our attention on greenwashing risk – with efforts to improve market understanding of greenwashing risks and to provide additional guidance to prevent, address and mitigate greenwashing risk.
In April, the UK Financial Conduct Authority (FCA) published its final non-handbook guidance on the anti-greenwashing rule (FG24/3) (AGR Guidance) aimed at assisting firms with compliance with the anti-greenwashing rule (ESG 4.31R) (AGR). The final AGR Guidance reflects FCA feedback to the guidance consultation (GC23/13) however remains principles-based for application across sectors. Both the AGR and AGR Guidance came into effect on 31 May 2024.
In early June, the European Supervisory Authorities – European Banking Authority (EBA), European Securities and Markets Authority and European Insurance and Occupational Pensions Authority (ESAs) – published their final reports on greenwashing in the financial sector.
The EBA Final Report refers to a "clear increase in the total number of potential greenwashing cases across all sectors, including EU Banks, from 2012 to 2023 with the total number of alleged cases continuing to increase in 2023." Unsurprisingly, climate change, impact on landscape and biodiversity and impact on local communities are cited as the most common factors subject to greenwashing claims in the EU financial sector.
Both the AGR Guidance and the EBA Final Report emphasise existing general rules and principles that can address and sanction misleading sustainability claims.1
Sustainability-linked loans (SLLs) are specifically referenced in the EBA Final Report and have also previously been the subject of an FCA letter published in June 2023. However, the comments made are not new and should not come as a surprise. The Green, Social and Sustainability-Linked Loan Principles emphasise the importance of ensuring the credibility and integrity of sustainable loan products setting out core components for the design of relevant loan products. The EBA Progress Report referred to these industry standards and guidance as the most relevant tool to mitigate greenwashing at the product level.
In this section we take a closer look at the AGR Guidance and EBA Final Report and examine application to the sustainable loan market.
Sukhvir Basran, Partner
1. See the EBA’s Progress Report for an overview of national legislative frameworks relating to greenwashing.
Financial Conduct Authority publishes final anti-greenwashing guidance
The AGR requires firms to ensure that any references to the sustainability characteristics (i.e. environmental and/or social characteristics) of a product or service are consistent with the sustainability characteristics of the relevant product/service and are fair, clear and not misleading. The AGR applies to all communications and the AGR Guidance refers to references which include (but are not limited to) “statements, assertions, strategies, targets, policies, information and images relating to a product or service”.
Highlights of AGR Guidance
The AGR Guidance sets out four key requirements for sustainability references and includes non-exhaustive examples (including of good practice) to support firms in applying the key requirements in the context of their business, products and services. Sustainability references should be as follows:
- Correct and capable of being substantiated: Sustainability-related claims should be factually correct, firms should not exaggerate or overstate the sustainability impact that a product or service has and firms should note that claims can be misleading if conflicting or contradictory information is provided. Firms should be able to support any claims at the time they are being made with robust and credible evidence and review of claims and supporting evidence should continue so long the claims are being communicated.
- Clear and presented in a way that can be understood: The FCA requires all firms to ensure that claims are transparent, straightforward and easily understood highlighting that the broad and general terms may be unclear and confusing and technical terms may require further clarification. The overall impression of a visual presentation should also be taken into account.
- Claims should be complete: Claims should be representative of the relevant product or service, and important information should not be omitted. The AGR Guidance specifically refers to relevant conditions and limitations of information, data or metrics and information which could result in a negative sustainability-impact. Firms are required to consider the entire life-cycle of the product or service rather than cherry pick relevant information.
- Comparisons to be fair and meaningful: Comparisons to previous or alternative offerings should be fair and meaningful in order to enable the audience to make an informed choice with all aspects of the comparison being clear.
The LMA’s response to the AGR Consultation can be found here.
ESAs publish final reports on greenwashing in the financial sector
The ESAs provide a common high level understanding 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 other market participants.”
The ESAs have also identified several core characteristics of greenwashing to help support the understanding of greenwashing which demonstrate the breadth and scope of greenwashing risk.
EBA Final Report – Highlights
The EBA Final Report builds on the EBA Progress Report with further analysis and data regarding key trends across companies, sectors and geography, outlining the types of greenwashing and also the impact of greenwashing on financial and other risks.
Figure 1.1: Impact of greenwashing on financial risks
Source: The EBA survey to CAs in 2022.
Greenwashing concerns relating to SLLs are specifically set out in the EBA Final Report. These refer primarily to the issues set out in the FCA letter published in June 2023 and claims of the SLL product being used as a marketing tool. Given that the SLL market is unregulated however the scale of any potential greenwashing in the SLL market is difficult to measure. The report also highlights the risk of greenwashing in the context of transition finance and sustainability-linked products arising as a result of mislabelled products and misrepresentation of strategies, trajectories and targets. In this respect, the EBA suggest that the policy framework for green loans (see Horizons01) could also investigate general purpose transition finance loans (such as SLLs for example) with the aim of providing greater clarity in the markets and reducing greenwashing.
The EBA Final Report also outlines practices which can be applied at product level and used by institutions to mitigate greenwashing risk. These include institutions adapting governance arrangements and internal processes, aligning with market standards (such as the LMA principles) and utilising external verification processes and providing clear and granular information about sustainability targets.
Commentary
In the Green, Social and Sustainability-Linked Loan Principles and related guidance, the LMA emphasises the importance of integrity and credibility of sustainable loan products. The LMA's Draft Provisions for SLLs go further in providing users with SLL terms along with detailed drafting notes referring to relevant market guidance, toolkits and standards. Both the AGR Guidance and the EBA Final Report highlight the use of market standards to assist lenders and borrowers in structuring, designing and drafting green, social and sustainability-linked loan facilities.
In Horizons01, we also included and analysed the latest market guidance, tools and resources and demonstrated how these materials could be used to support the design, structuring and drafting of sustainable loan products. The AGR Guidance and the EBA Final Report2 provide further detailed examples, best practice and resources which can be used to prevent, address and mitigate greenwashing risk and address challenges around data, usability and consistency of information. As indicated in Horizons01 and emphasised in the EBA Final Report, market participants should also leverage voluntary guidance and regulation such as the EU Taxonomy to support the credibility and integrity of sustainable loan products and safeguard against greenwashing risk. In light of the AGR Guidance and the EBA Final Report, it is clear that the range of terms used by market participants to refer to and/or label sustainable loans must be very carefully considered. The terms "sustainability-linked loans", ESG-linked loans, KPI-ratchet, for example, are all used to describe a loan product which may align with all or some of the LMA Sustainability-Linked Loan Principles to varying degrees. Green and social loans may align with the LMA’s Green and/or Social Loan Principles and/or a lender’s internal framework (see Horizons01). Market participants should provide clearer and more complete information regarding the basis on which such terms are used, the framework that the loan product is aligned to and, regardless of the label, provide supporting evidence of the relevant claims.
In addition, assessing sustainable loan products from a regulatory and internal governance and control perspective is essential. This requires well informed due diligence and investment processes, the use of green, social and SLL frameworks which set out robust internal standards regarding relevant data, strategies and terms. Market participants should also therefore ensure that internal processes reflect claims in a systemic way including when referring to, for example, “ESG integration”, “SDG alignment”, “client engagement and support” etc.
It is also worth pointing out the breadth and scope of greenwashing risk (set out in detail in both the AGR Guidance and the EBA Final Report). Greenwashing can be unintentional and is not limited to marketing or syndication materials, can occur at any stage of the business/investment cycle and extends to relevant communications across the sustainable value chain.
2. Chapter 4 (Addressing greenwashing through the EU Regulatory Framework) and Chapter 5 (Practices to mitigate greenwashing risks by institutions)