Ashurst's regular briefing on the evolving risk of greenwashing and how to manage it.

Welcome to the second issue of Greenwatch, where we look at the risk of greenwashing – and how companies can mitigate it.

The European Union leads the way in "green" regulation – its innovative policies affect corporate behaviour beyond the EU's borders. We explore proposed new legislation to police the environmental statements made to consumers and what it will mean in practice.

We also look at a recent high-profile enforcement action in the financial services sector in the United States, and it's potential effect on processes and controls. This is particularly relevant for businesses seeking to emphasise their own ESG and sustainability profile by comparing themselves with their peers.

The management and governance of data is essential to reduce greenwashing risk. We explore how regulators are keeping a close eye on this.

Finally, we consider a recent report in the financial services sector containing red flags for institutions seeking to mitigate greenwashing risk.

What's been happening?

Europe: EU Green Claims Directive

"The EU is taking action to address greenwashing, by protecting consumers and the environment."

Martin Eimer, Legal

In 2020, a study by the European Commission revealed that a large number of environmental statements made by companies in relation to their products and services were unreliable. The Commission has proposed new legislation – the EU Green Claims Directive (GCD) - which will introduce, on an EU-wide, harmonised basis, new criteria to stop companies from making misleading ("greenwashing") claims about the environmental benefits of their offerings.

The GCD aims to create a level playing field for businesses; protect consumers who are making decisions about buying allegedly sustainable products and services; and ultimately, protect the environment.

First adopted in March 2023, the proposed Directive seeks to make "green claims" reliable, comparable and verifiable across the EU. The draft Directive requires such claims and labels to be independently verified and proven with scientific evidence. Its impact on medium or large businesses is likely to be significant. Small businesses with fewer than 10 employees and a turnover not exceeding €2 million are expected to be excluded from the GCD's scope of application. Enterprises will face higher running costs and even greater compliance efforts in the future. The communication of environmental claims and labels, previously handled mainly by marketing departments, will need to be carried out in close consultation with other departments such as compliance, and be supported by proper evidence.

The GCD's consumer protection angle could open the door to mass damages arising from misleading green claims, making it an ideal candidate for the scope of the Representative Actions Directive, which allows for (bundled) representative court actions. In addition to the administrative burden, corporates would then also need to manage the litigation risk arising in this context.

The GCD proposal is subject to the approval of the European Parliament and the Council. The process may be delayed due to the upcoming European Parliament elections in June 2024. Since it is a Directive, and is not binding automatically, EU member states will have 18 months to transpose it into national law (and a further 6 months before the rules are applied).

What does this mean for you?

The GCD will apply to voluntary business-to-consumer claims (including in the form of an environmental label) relating to environmental impact, aspects or performance of a product or the trader itself and provides more specific rules than existing consumer protection legislation.

The GCD's focus is to ensure that consumers (and genuinely sustainable companies) are protected against false environmental claims, by: harmonising minimum requirements for traders to provide evidence when making voluntary environmental claims; developing an EU labelling scheme; and enforcing new procedures and penalties for non-compliance.

United States: the SEC settles a greenwashing case

"Regulators across the world are focused on greenwashing issues. The SEC is at the forefront of this. This high-profile settlement shows what can go wrong in the financial services industry, and the failings in processes and controls to look out for."

Elena Lambros, Risk Advisory

On 25 September 2023, the US Securities and Exchange Commission (SEC) published a settlement with US - registered investment adviser, DWS Investment Management Americas, Inc. (DIMA), over misleading claims and failures relating to the integration of ESG factors into its investment products. DIMA marketed itself as a leader in ESG, offering ESG-integrated products, with its investment teams using its proprietary ESG tool to make investment decisions.

The SEC found that DIMA failed to have processes and controls in place to ensure that its personnel implemented its publicly available ESG integration policy in a manner consistent with its public representations. This lack of oversight and failure to monitor compliance resulted in misleading representations to clients and investors about the extent of its consideration of ESG aspects. DIMA consented to the SEC's Order, which comprised a censure, a cease-and-desist order and a civil money penalty of US$19 million.

This case is a prime example of how greenwashing risk manifests itself as a regulatory/litigation risk. Regulators have an increased focus on and commitment to addressing greenwashing in the financial industry. Moreover, the case highlights the importance of effective procedures and controls to ensure that public representations about ESG are accurate and publicly available policies are adequately implemented.

What does this mean for you?

Companies should consider putting controls in place when making eco-claims, and if you identify any failings or concerns about how these controls are working, take steps as soon as possible to address them. Specifically:

  • focus on your ESG related public disclosures;
  • ensure you're setting sensible and attainable ESG commitments;
  • review your processes and procedures for products/services marketed as ESG-related; and
  • keep an eye on the SEC's proposals and actions, including the surrounding working groups.

Data/AI to combat greenwashing

"Having trusted data is key to achieving ESG commitments"

Matthew Worsfold, Risk Advisory

We are seeing increased focus from organisations to uplift data capture processes and systems to meet disclosure requirements, avoid greenwashing claims and have reliable data to confidently engage with stakeholders. To achieve these, data relied upon to meet ESG requirements must be effectively managed and governed. It requires having a clear understanding of data requirements, documenting definitions to ensure consistent usage, and implementing data quality rules to ensure reliability. Firms should also document the flow of data from point of capture to the point of consumption to enable traceability, mitigate risks with controls to minimise issues and monitor data on an ongoing basis to enable trends and insights.

With the increased focus on data in providing transparency, there is a corresponding increase in focus from regulators on how ESG data is managed. For example, the Financial Conduct Authority (FCA) issued a feedback paper on the regulatory oversight of ESG data and ratings providers and whether they should be bought into its regulatory perimeter. While this is being considered, the FCA has convened an industry-led group to develop and follow a voluntary Code of Conduct for ESG data and ratings providers to '(i) help build trust in the market, (ii) protect market integrity, and (iii) promote effective competition. Similar approaches are actively considered in Japan and the EU.

What does this mean for you?

Data and emerging technologies like AI have huge potential to assist companies with ESG concerns. Firms can closely monitor the ESG Data and Ratings Working Group (DRWG) that is developing a comprehensive, proportionate and globally consistent voluntary Code of Conduct.

Consider the use of AI-powered tools to identify under and/or over reporting of climate-related risk and readiness that could potentially unearth greenwashing risk.

Greenwashing developments in financial services

"The risk of climate related litigation is not incremental and continues to grow, crucially in terms of the legal arguments being used and the diverse routes to address such claims. Greenwashing is a major source of that risk."

Anna Varga , Legal

In September 2023, the Network for Greening the Financial System (NGFS) published a technical document about recent trends and developments in climate litigation. The report expects climate-related litigation to continue to increase in terms of its nature, frequency, diversity of corporate actor targets, the scope and inevitably the variety of the legal arguments for such claims.

The report notes that climate-related litigation against financial institutions is an emerging trend, specifically in relation to greenwashing - and the prevalence of climate-related disclosures increases the likelihood that such risks will crystallise. The source of the risk is multi-faceted and claims may be triggered by various actors, including regulators and supervisory authorities, NGOs and private individuals.

As a result, such liability risk may need to be incorporated into financial institutions' operational risk management to take account of the financial impact of reputational harm to those institutions.

In a similar vein to climate-related disclosures, the NGFS expects that litigation will gather momentum, in line with the development of climate-related legislation on corporate due diligence and duties, as well as greenwashing. Climate litigation may (i) be a driver for new legislation, (ii) fill any gaps where existing legislation is lacking or lagging behind, or (iii) provide grounds for future litigation.

The report also notes certain drivers of climate-related litigation. Here we highlight one for example: climate science shows that climate change is accelerating and will require decisive action this decade.

What does this mean for you?

Climate litigation will continue to affect the transition costs and risks faced by financial and non-financial entities. That risk may increase in the light of the drivers identified in the report.

Stay abreast of the forward-looking climate risk assessments by monitoring the NGFS guidance that supports banks, supervisors and the broader financial community to analyse climate-related financial risks.