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Regulators are Intensifying Their Scrutiny of Greenwashing

Although sustainable finance is clearly gaining momentum in the financial sector, is every “sustainable finance” product worthy of the label?

Key takeaways:

  • Greenwashing can generate reputational and material legal and liability risks.
  • Elements of unfair competition laws, consumer protection laws, and consumer rights address greenwashing, even if the word “greenwashing” doesn’t appear in the regulation.
  • There are laws that specifically target greenwashing in the financial sector.

A growing demand for sustainability-related investments has combined with a rapidly evolving market to create conditions ripe for greenwashing. There is an ever-increasing risk that financial institutions could be deceiving clients and policy makers about their sustainability-related practices and commitments at the product as well as entity levels.

Considering this, supervisors are progressively incentivized to look closely at financial institutions’ practices and sustainability-related claims. This heightened scrutiny is anticipated because there are so many regulations that focus on sustainability-related products and services as well as corporate practices. Besides leading to reputational risks, being linked to greenwashing practices can also generate material legal and liability risks.

What is greenwashing?

The term “greenwashing” refers to the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly when, in fact, basic environmental standards have not been met[1]. These types of claims can lead to an inaccurate assessment/perception of an entity’s sustainability practices.

 

How to navigate the greenwashing regulatory landscape

As a starting point, it is important to know that many long-standing laws and regulations tackle greenwashing practices. However, these rules usually do not use the term “greenwashing.” Instead, they use words like “misleading,” “false,” and “deceptive,” and these laws typically do not differentiate between different types of products, services, or sectors.

Be aware that these generic laws and regulations still apply to financial institutions and their offerings.

Generally, there are two types of rules:

  1. Unfair competition laws establish how market players, i.e. competitors, must behave when abiding by expectations related to good faith, trust, and fair business conduct.
    • A key pillar of unfair competition laws is the prohibition of deceptive practices, such as false and misleading advertising, in other words, the prohibition of greenwashing.
    • Countries like Germany, New Zealand, Australia, and the USA have seen more cases brought to their courts that allege greenwashing under unfair competition laws. A Swiss parliamentary initiative to include greenwashing on the list of unfair practices under the Swiss Unfair Competition Act was rejected in June 2022.
    • In March 2022, the EU Commission proposed amendments to the directives on unfair commercial practices and misleading and comparative advertising. Greenwashing and intentional obsolescence would be prohibited, and it would be illegal for sellers to advertise their products as green or environmentally friendly unless these advantages can be proved.
  2. Consumer protection laws aim to insulate consumers from abusive, fraudulent, and unfair practices by entities offering them products and services. Consequently, transparency and easy-to-understand communication that aims to reduce the imbalance of information between parties is a core expectation of this group of laws. Greenwashing practices can also be characterized as a violation of consumers’ rights. In some countries, such as Australia and Switzerland, consumer rights are addressed within unfair competition laws, while in others, like Brazil and Italy, there are separate laws on consumer protection.

Regulations specific to the financial sector

In addition to unfair competition and consumer protection laws, financial institutions must observe regulations that are specific to financial products and services.

EU regulations

The EU has taken important steps to address greenwashing in the financial market by adopting sustainable-finance-related policies and legislation. The EU has introduced legislation to preserve the reliability and transparency of environmental, social, and governance (ESG) disclosures, such as the Taxonomy Regulation and Sustainable Finance Disclosure Regulation.

However, the Commission considers it important to continue monitoring this issue and to assess the effectiveness of supervisory activities. To support this effort, the European Commission asked the European supervisory authorities to give advice on greenwashing risks and the supervision of sustainable finance policies.

Currently, even within regions sharing a high degree of legal coordination like the European Union, regulatory expectations for what is deemed to be “green,” “sustainable,” or “fair” products can vary significantly. Be sure to consider the requirements of the location where a product is registered, managed, and offered. This inconsistency is likely to present financial institutions with challenges when setting products’ target markets and when helping clients to identify their sustainability preferences.

Swiss regulations

According to the Swiss Federal Act on Collective Investment Schemes (CISA), collective investment schemes are prohibited from providing “false or misleading information in advertising material” (article 149). The way a financial product is categorized within a collective investment scheme must not cause any confusion (article 12). Therefore, one could argue that it is prohibited to make claims of sustainability that might be considered as false, misleading, or confusing advertisement.

Building on the CISA, in November 2021 the Swiss Financial Market Supervisory Authority (FINMA) published Guidance 05/2021 (Guidance) on how to prevent and combat greenwashing. This document offers guidelines for providing sustainability-related information at the fund level as well as on how an organization should be structured to best manage products with a “sustainable” designation.

US regulations

In 2001, the US Securities and Exchange Commission (SEC) added the Names Rule to Section 35(d) of the Investment Company Act to address deceptive or misleading names. This provision states that it is “unlawful for any registered investment company to adopt as a part of the name or title of such company, or of any securities of which it is the issuer, any word or words that the Commission finds are materially deceptive or misleading.”

The rule further requires funds with names that suggest a focus on a particular type of investment or geographic region to invest at least 80 percent of their assets in the type of investment suggested by their names.

Further demonstrating that the SEC considers greenwashing to be a major risk for financial institutions (and to further protect investors), in May 2022 the SEC proposed amending the Names Rule by extending it to any fund with a name indicating that its investment decisions consider ESG factors and by introducing new reporting and disclosure requirements.

The path through the regulatory landscape

At ECOFACT, we closely follow developments in ESG and climate-related regulatory developments. We are monitoring the signals from regulators and keeping track of the steps they are taking. The above developments are an example of the multitude of reputational, legal and liability risks associated with sustainable finance.

1. Recital (11) of the EU Taxonomy Regulation. EUR-Lex - 32020R0852 - EN - EUR-Lex (europa.eu)

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