What’s greenwashing? And why is it an issue?
Greenwashing refers to the practice of misleadingly presenting or exaggerating the environmental benefits or sustainability of a product, service, or company to deceive consumers or investors. It involves making false or unsubstantiated claims about the environmental impact or sustainability practices, giving the impression of being more environmentally friendly than the entity (the funds or assets under management) truly is. Greenwashing can occur both intentionally and unintentionally. Intentional greenwashing refers to deliberate attempts to manipulate or misrepresent the sustainable objectives and characteristics of financial products. The intention behind intentional greenwashing is to attract environmentally conscious consumers or investors without actually implementing meaningful sustainability measures. Unintentional greenwashing, on the other hand, refers to a misalignment between the investors’ expectations of what “green” should be and what green really means in the providers’ offers. This can happen due to a lack of understanding, inaccurate data, or incomplete information about the true environmental consequences of their activities.
The terms ESG, green, and sustainable are important. They help sell and using them for the wrong purpose is misleading for investors. The sustainable financial sector is a huge (37 trillion AUM in 2022) and constantly growing sector (53 trillion by 2025). The damage greenwashing causes to investors can be important and can touch everyone. The main issue is that it makes it difficult for investors and especially private investors to identify which option is best for them. The names of the funds can be misleading, the actual positions in the portfolio may be difficult to find, and it is not always easy to identify the sustainability of an action let alone an obligation or more complex financial products. Furthermore, greenwashing undermines the trust of investors, consumers, and other stakeholders in sustainability efforts. It undermines the entire sector and the efforts made and hinders progress toward a truly sustainable economy.
What is SFDR? What’s new on level II? What is taxonomy?
The Sustainable Finance Disclosure Requirements (SFDR) is a European regulation set up to enhance the transparency of the durability of financial products and the financial industry. It has been enforced in March 2021 and since January 1st, the regulator has set up level II. Under the SFDR, the investment strategy must be classified into three subcategories (Art. 6, Art. 8 & Art.9) depending on the sustainability level and the investment objective. In addition to defining the investment and the corresponding article, asset managers must now include information about the process to achieve those investment strategies and the metrics used.
The SFDR taxonomy refers to the technical screening criteria and classification system established under SFDR. It provides a framework for defining environmentally sustainable economic activities and sets out the criteria that must be met for an economic activity to be considered environmentally sustainable. The SFDR taxonomy aims to create a common language and classification system for sustainable finance within the European Union. It helps financial market participants to identify and disclose which investments or financial products align with environmental objectives. By establishing a standardized taxonomy, the SFDR aims to provide clarity and transparency on sustainable investments, to enable comparability between financial products and help prevent greenwashing.
Taxonomy requires industries and companies to disclose their revenue and expenditure in accordance with the specified categories. Asset management companies must report the percentage of their AUM in line with the taxonomy, especially for funds classified as Art. 8 and Art. 9. Taxonomy provides the criteria and framework for classifying economic activities as environmentally sustainable while the SFDR mandates financial market participants to disclose how their products align with the taxonomy. Together they promote transparency and consistency in sustainability disclosure enabling investors to make informed decisions regarding sustainable investment.
SFDR and greenwashing
Sustainability has been a concern for a long time and many have seen there an opportunity to marketize these subjects. The financial sector is no exception. As concerns about the environment, sustainability, and durability have grown, sustainable financial possibilities have risen simultaneously. With the introduction of SFDR in March 2021, European regulators aim to fight greenwashing and disinformation in the sectors. The implementation of level II on the first of January 2023 tackles some of the weaknesses of the first version.
During the last quarter of 2022, the investment industries have seen for the first time a reduction in the Art. 9 funds investment. This is mainly due to the massive downgrade of Art. 9 to Art. 8 in prevision of the level II implementation. More than 300 funds were involved for a total AUM of 170 billion and a further 99 billion have followed this trend in January. Thanks to this new regulation, greenwashing is becoming increasingly complicated. As the transparency level about sustainability increases, investors and market participants can make more informed decisions and tackle unintentional greenwashing. Investors can meet their expectations by searching and investigating their investment opportunities before they make them.
Intentional greenwashing is always more difficult to address because it is based on voluntary misleading purposes. It is always possible to take advantage of a new regulation. SFDR II and the taxonomy linked help fight those fraudulent behaviors. So, it is more difficult for asset managers to deliberately exaggerate the durability impact of their portfolio. Indeed, thanks to the increasing amount of reporting needed, the transparency also increases, and the intentional greenwashing possibilities and fraudulent uses of sustainable names and characteristics are reduced.
The green label has gained so much worth during the last few decades in all industries that fighting greenwashing has become more complicated. Fortunately for European investors, regulators have decided to tackle the issue. It is with these regulations and their continuous improvement that the regulators can oppose greenwashing.
Sources
- Capital Monitor. (n.d.). Explainer: What are the SFDR regulations? Retrieved from https://capitalmonitor.ai/regions/europe/explainer-what-are-the-sfdr-regulations/
- Worldfavor. (n.d.). SFDR: What are the PAI indicators? Retrieved from https://blog.worldfavor.com/sfdr-what-are-the-pai-indicators
- Geektime. (n.d.). EU Taxonomy and SFDR explained. Retrieved from https://www.geektime.com/eu-taxonomy-and-sfdr-explained/
- ESG Clarity. (n.d.). One year on from SFDR: More confusion and greenwashing. Retrieved from https://esgclarity.com/one-year-on-from-sfdr-more-confusion-and-greenwashing/
- CACEIS. (n.d.). Level 2 SFDR measures strengthen requirements vis-à-vis investors. Retrieved from https://www.caceis.com/fr/media-room/actualites/a-la-une/article/level-2-sfdr-measures-strengthen-requirements-vis-a-vis-investors/
- Economic Times. (n.d.). $1.9bn in global AUM, sustainable investments provide greater stability to investors. Retrieved from https://economictimes.indiatimes.com/markets/stocks/news/1-9bn-in-global-aum-sustainable-investments-provide-greater-stability-to-investors/articleshow/96470971.cms?from=mdr
- Morningstar. (n.d.). Will the SFDR prevent greenwashing? Retrieved from https://www.morningstar.co.uk/uk/news/213385/will-the-sfdr-prevent-greenwashing.aspx
- Funds Europe. (n.d.). €270bn of Article 9 ETF funds downgraded. Retrieved from https://www.funds-europe.com/news/270bn-of-article-9-etf-funds-downgraded#:~:text=The%20study%20revealed%20that%20307,were%20downgraded%20in%20January%202023.