Exploring the Legality of Greenwashing

Greenwashing is a major risk to the future of ESG investing, but there is no clear consensus on what it means in a legal or regulatory context. The term has become increasingly common with the rise of ESG investing, and is typically used when companies, individuals, or governments overstate, misrepresent, or outright lie about their climate credentials. For example, a company might claim to be reducing its carbon footprint, but fail to mention that the calculation excludes emissions produced by its customers or suppliers. Or an asset manager might exaggerate the environmental, social, and governance standards it uses to allocate clients' money. But the lack of a clear definition makes it difficult to enforce greenwashing in a legal sense.
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"The battle to stamp out greenwashing is being hindered by the lack of a clear and common definition of what constitutes greenwashing across jurisdictions," said Maia Godemer, a sustainable finance analyst at BloombergNEF based in London. "The market can only continue to flourish if regulators build a common framework around what is considered environmentally or socially sustainable."
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Policymakers in Europe have been working hard to develop a framework for regulating artificial intelligence, but complications continue to arise.
The European Securities and Markets Authority (ESMA) has listed tackling greenwashing as one of its top priorities. However, the markets watchdog struggles to specifically define what greenwashing is.
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In November, the European Securities and Markets Authority (ESMA), along with the European Banking Authority and the European Insurance and Occupational Pensions Authority, launched a joint review to gauge the scale of exaggerated ESG investing statements. The review is part of an effort to evaluate how well existing regulations are working, and to gather useful and concrete examples of greenwashing.
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According to a recent report, fund managers have downgraded more than $140 billion in ESG assets. This is a significant increase from previous years, and it highlights the growing importance of environmental, social, and governance factors in the investment world.
The European regulatory effort has had a dramatic impact, with many asset managers being forced to stop claiming that their investments are sustainable if they don't meet the new standards.
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But the lack of conformity among agencies and jurisdictions is "leading to misinterpretation and inconsistent application of the rules," Godemer said. Unless there's more clarity and consistency, she said it's likely investors will simply pare back their holdings of funds advertised as sustainable.
The European Union's Sustainable Finance Disclosure Regulation (SFDR) may be a prime example of this. Instead of providing a uniform interpretation of what is an ESG fund and what is not, it has prompted concern that investors have put their money in funds marketed as pure-play ESG products when they are not.
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During the second half of last year, financial giants including BlackRock Inc., Amundi SA, Axa Investment Managers and the investment arm of Banque Pictet & Cie SA stopped claiming that $140 billion worth of their funds actually qualified for the EU’s top ESG designation, known as Article 9.
The EU has clarified its definition of Article 9 funds, saying that the labeling must be reserved for 100% sustainable investments. This is a positive step towards ensuring that investors are able to make informed decisions about where to put their money.
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Now there are calls for the European Commission and ESMA to ensure transparency by financial firms when they are forced to reclassify funds. Retail clients who are concerned about being exposed to greenwashing have started to hold those firms accountable, accusing them of keeping the flow of information on ESG downgrades to a minimum.
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The market for sustainability-linked bonds is growing rapidly, but it has been tainted by confusion and anger among investors and companies.
"Financial market participants also need to increase their knowledge and educate themselves," Godemer said. Countries "will never completely agree on fully aligning their standards," but regulators should at least develop an international structure that covers "the basics of sustainability reporting."
If companies don't take action to address environmental concerns, she warns, they will face more greenwashing-related litigation.