ESMA: Clarifying sustainable investment ‘crucial’ to mitigate greenwashing

Europe’s financial watchdog ESMA has stated that clarifying what qualifies as sustainable investment is “crucial” in mitigating greenwashing risks. 

The regulator made the recommendation in a report to the European Commission published on Thursday, in a section on potential remediation actions to address greenwashing. 

It follows the commission’s response in April to a question put forward by the three European Supervisory Authorities (ESAs) – which include ESMA – on how sustainable investments should be understood in the context of the EU’s anti-greenwashing legislation, the Sustainable Finance Disclosure Regulation (SFDR).  

The commission said it was up to investment managers to set their own definition on what constitutes a sustainable investment under SFDR, as long as investments fulfil the three tests of contributing to an environmental or social objective, not causing significant harm to objectives and meeting good governance practices. 

But in its report, ESMA stated that the SFDR definition of sustainable investment is characterised by “a high level of flexibility and absence of shared, predefined metrics and threshold for an investment’s contribution to a sustainable objective”.

It contrasted this with the definition of environmentally sustainable activities in the TR [Taxonomy Regulation], “which uses science-based and clear Technical Screening Criteria (TSC)”. 

The regulator added that there might be “merit” in additional clarification on best practices for defining the minimum contribution to a sustainable objective under SFDR, “as well as regarding selecting adequate sustainability indicators to measure it”. 

ESMA said such work could be done by the supervisory authorities and could entail them giving concrete examples of what the ESAs consider to be best practices, “or unreasonable/sub-optimal practices on sustainability indicators in general – and on impact measures in particular”. 

This work would help institutional investors challenge their managers on their definition of contribution and choice of sustainability indicators, ESMA said.

Alternatively, ESMA suggested changes to the SFDR – “specifically, to the reference of contribution to a sustainable objective and inclusion of a reference to adequate measures for this contribution”. 

Defining greenwashing 

ESMA’s report to the commission was one of three put forward by the ESAs on the issue of greenwashing. 

As part of this work, the regulatory trinity – which also includes EIOPA and the EBA – put forward their “common high-level understanding” of what constitutes greenwashing.

They defined it 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.” 

This definition builds on existing references in other regulations and is designed to provide “a shared reference point” for regulators and market players, ESMA said. But the regulator added that it is “too early to take a position on whether and in which form the high-level understanding should be integrated into EU legislation”. 

The reports from the ESAs, representing more than 200 pages of advice, fulfil part of the commission’s mandate that the trio provide feedback on risks associated with, and instances of, greenwashing in the European financial sector, as well as steps they have taken on the issue. 

To inform this work, the ESAs put a call out to the market for examples of greenwashing in November. 

Responses to the consultation are expected to be published in the coming weeks. Europe’s financial trade bodies have already made their views public, however, pushing back against what they regard as excessively broad definitions of greenwashing. 

Misleading claims

The ESAs stressed in their reports that sustainability-related misleading claims can occur and spread either intentionally or unintentionally. 

In its report to the commission, the EBA revealed that a quantitative analysis had shown a “clear increase in the total number of potential cases of greenwashing across all sectors, including for EU banks”. 

EIOPA raised the issue of competency among national regulators as an issue, noting that “only 10 NCAs [National Competent Authorities] believe they have sufficient resources and expertise to tackle greenwashing, 17 believe they do not”. 

Sustainability claims around engagement was one of the areas ESMA found to be “particularly exposed to greenwashing risks”. “There are concerns that issuers or asset managers make claims about engaging with key stakeholders or investee companies with little substantiation,” it stated. 

The regulator mulled the introduction of “standardised disclosures” as one way of mitigating this risk.  

Another area identified by ESMA as a concern for the investment management industry was “competency greenwashing”.  

“There appears to be a new trend of professionals relying on specific introductory-level ESG certificates to display their expertise which could be deemed neither fit nor proper,” it said. 

The ESAs will publish final greenwashing reports in May 2024 and will consider making final recommendations, “including on possible changes to the EU regulatory framework”.