The three European Supervisory Authorities ("ESAs") (EBA, EIOPA and ESMA) have each published their Progress Reports to the European Commission on greenwashing in the financial sector.

The Progress Reports mark the first part of the ESAs' response to the Commission's request for input in May 2022 on the phenomenon of greenwashing and the implementation, supervision and enforcement of sustainable finance policies aimed at preventing greenwashing. The ESAs' Final Reports will be published in May 2024 following which the Commission will consider the ESAs' final recommendations, including possible changes to the EU regulatory framework.

In the reports, the ESAs have developed a common high-level understanding of greenwashing 'as a practice where 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.'

Key points from ESMA’s Progress Report

As the EBA and EIPOA reports are focused on the banking and insurance and pension sectors, respectively, it is ESMA’s report that will be of greatest interest to asset managers.

ESMA’s Report focuses on four specific sectors under ESMA’s remit: investment management, issuers, benchmark administrators and investment service providers. The Report looks at the causes of greenwashing and their drivers, and provides high-level insights into monitoring and supervision of greenwashing.

For asset managers specifically, ESMA identifies the following areas as being particularly exposed to greenwashing risks:

  • a fund’s or manager’s engagement with investee companies (namely unsubstantiated or empty engagement strategies that are neither consistent nor transparent and do not address progress of engagement);
  • ESG strategy, policies and credentials (issues relating to unsubstantiated, exaggerated and inconsistent claims in fund documents);
  • ESG governance (such as not ensuring that an ESG policy or ESG implementation is complied with);
  • misleading claims on sustainability impact (such as lack of commitment and specificity in sustainable characteristics for SFDR funds and overemphasising certain claims); and,
  • fund names (which ESMA highlights as being particularly important for retail investors’ decisions).

The causes of greenwashing are identified as the result of multiple inter-related drivers. Notably, ESMA highlights the current provisions of the SFDR as perceivably driving greenwashing in respect of the lack of clarity around key concepts (such as ‘sustainable investments’ and the DNSH test) as well as the high degree of flexibility and lack of thresholds for Article 9 products.

The market’s use of the SFDR as a labelling regime is further raised as an issue. In addition, ESMA highlight how participants face challenges across the ‘sustainable investment value chain’ (“SIVC”) in implementing the necessary governance processes and tools that support high-quality sustainability disclosures and transition efforts. In this context, managers are identified as having difficulties in producing and accessing relevant, high-quality sustainability data.

Implementation challenges for both managers and for regulators created by the fast-moving regulatory framework are also identified, with ESMA highlighting the need for both participants and regulators to build sustainability expertise.

The Report sets out ESMA’s preliminary thinking in terms of remediating greenwashing risks, which includes:

  • clarifying key concepts under the SFDR, in particular what qualifies as a “sustainable investment” and more closely aligning the DNSH tests under the SFDR, the Benchmark Regulation and Taxonomy Regulation;
  • increasing the supply of standardised, audited forward-looking ESG information for the emission reduction targets and transition plans (the application of the CSRD is expected to help deliver this);
  • managers across the SIVC have a responsibility to communicate sustainability information in a balanced and substantiated manner - crucial to this will be to ensure that managersimplement monitoring systems and reporting regularly on progress;
  • further clarifying due diligence responsibilities of managers in the value chain in order to mitigate unintentional spreading of misleading claims (interestingly, ESMA identify asset managers offering funds of funds products as having a responsibility here);
  • enhancing the reliability and comprehensiveness of sustainability data through further transparency on ESG data methodologies, clarifications on the use and calculation of estimates, external verification and auditing; and
  • in respect of supporting comprehensibility for retail investors, establishing a reliable and well-designed labelling scheme for sustainable financial products and tackling ESG literacy gaps.

Whilst the proposed remediation actions in the Reports are preliminary (and will be further refined in the Final Reports) it provides an insight into the key areas of regulatory thinking for ESMA and prospective changes that could come further down the line.

Greenwashing, and addressing its risks, will remain a key focus area for the ESAs and the Reports should be considered by managers when launching and marketing new products.