Labanya Prakash Jena and Prasad Ashok Thakur
Greenwashing is a threat to green transition efforts. It ruins the credibility of the system’s sustainable efforts.
There are several factors contributing to greenwashing risk. The market demand and investors’ pressure for environment-friendly products and services are forcing companies to find loopholes in the checks and balances created. The lack of standardisation and clarity on what constitutes “green” or “sustainable” has allowed for broad and sometimes misleading interpretations. Reporting and disclosing the numbers are often complex and inconsistent, with various frameworks and standards leading to confusing, inconsistent, and often, opaque results.
In addition, regulatory gaps and inadequate enforcement allow entities to make baseless claims without facing real consequences. Additionally, the complexity and opacity of supply chains make it difficult to verify sustainability claims, further enabling greenwashing practices.
Greenwashing in the financial sector
One in every four Climate-related ESG risk incidents globally was tied to greenwashing. The banking and financial services sectors saw a 70% increase in climate related greenwashing incidents in the last twelve months (FY Sept. 2023 vs. FY Sept 2022).
There are three primary mechanisms of greenwashing in the financial sector:
- Financial instruments
- Impact
- Commitment
Banks and financial institutions sell green retail loans and mortgages targeted to buy or build green assets, but they often finance or underwrite sustainable and sustainability-linked financing to activities that are not fully green or sustainable.
Asset managers and financial services providers sell ‘green’ stocks, funds, equity indices, and bonds to their clients. Still, many times, the proceeds from issuing these financial instruments are not fully used for green activities and, for the most part, are used for refinancing instead of creating new green assets.
These institutions also make unsubstantiated claims that green loans and investments will allow customers to reduce GHG significantly, while in reality, the benefits are marginal. For example, sustainability-linked bonds (SLBs) and sustainability-linked loans (SLL) can only reduce GHG emissions marginally. Without making any investment in low-carbon technologies, significantly. In the case of SLBs and SLLs, KPIs account for only a tiny portion of CO2 emissions.
Banks and financial institutions also make public commitments to reduce emissions, but it is restricted to scope 1 and 2 when scope 3 emissions are more relevant and pressing. Even if they commit to reducing scope 3 emissions from their investment or lending portfolio to net zero emissions, their transition plans are not credible.
Their claims about integrating climate considerations into capital allocation and financing decisions are misleading as they falsely assert that proceeds from stocks and bonds marketed as sustainable are directed towards the entity’s transition plans, when in reality, they merely facilitate investor subscriptions.
Impact of greenwashing risk
The recurring issue of greenwashing poses significant reputational risks, driven by media campaigns, consumer associations, and publicised customer complaints. This can lead to operational risks, including liability claims due to misrepresentation of products and litigation cases.
As a result, corporations may lose investor and depositor confidence, leading to disaffection and potential income losses from conduct failures and fines.
Additionally, they could face liability and funding risks due to reduced market access or less favourable terms, driven by reputational damage. Investors might also divest green-labelled financial instruments, causing a decline in their market value.
The Way Forward
Here are three ways to solve this problem:
Publish methodology: Banks should publish a methodology for quantifying their green finance targets. For example, they can set a target for clean energy to constitute at least 60% of their energy portfolio by 2030, no new fossil fuel financing after 262, or EVs can constitute 30% of their ground transportation loan book.
Disclose coverage of green financing: Financial institutions should primarily cover financing activities that result in the bank’s allocation or facilitation of capital. These include lending, proprietary investment, and capital markets facilitation. All these categories of support must be reported separately.
Disclose impact: Banks should complement overarching green finance targets across portfolios with targets set at sector or activity level (e.g. clean energy sector or electric transportation). This will provide transparency about the targets’ intended real-world impact.
Legal and Regulatory Frameworks to Address Greenwashing Risk
Most jurisdictions have established frameworks to address greenwashing risks, though the coverage varies. Some jurisdictions have introduced specific requirements to regulate greenwashing risks.
These frameworks can focus solely on banks, financial institutions, and asset managers, investment advisers and securities firms, ESG rating and data products providers.
Sustainable Finance Disclosures Regulation (SFDR) in the EU requires all market participants, including asset managers, to disclose corporate-level sustainability information and specific product-level disclosures, including periodic reporting.
Egypt, Hong Kong, Singapore, and the UK have introduced requirements and guidance for asset managers based on Task Force on Climate-related Financial Disclosures (TCFD) recommendations (now merged with IFRS)—a phased approach in Hong Kong.
The Securities and Futures Commission (SFC) adopted a two-tiered approach, categorising fund managers based on assets under management, with baseline requirements for all and enhanced requirements for larger managers.
Stronger regulations and clearer standards are essential to combat greenwashing. Financial institutions must ensure their green claims are genuine to maintain trust and truly support sustainability efforts.
Labanya is an advisor at the Climate and Sustainability Initiative (CSI) and a sustainable finance specialist at the Institute for Energy Economics and Financial Analysis (IEEFA)
Prasad Ashok Thakur is an alumnus of IIT Bombay and IIM Ahmedabad.
Views are personal.
