A phenomenon, known as greenwashing, is becoming increasingly prevalent in the EU financial sector. Greenwashing is a practice whereby 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. It may not be recognized as imminent risk by many, but it could potentially lead to reputational damage, litigation costs, and mistrust in sustainable financial products. Even worse, the above risks could result in financial instability due to lower credibility and a drop in liquidity of financial markets. To address these challenges, the European Supervisory Authorities (ESAs) were requested by the European Commission to provide a report on greenwashing in the financial sector in May 2022. In response to the request, ESAs, namely European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and Markets Authority (ESMA) released their final reports on greenwashing on June 4, 2024. The final reports centered on greenwashing risks and the implementation of sustainability-related regulations aimed at countering greenwashing in the financial sector. In this article, we will dig deeper into the EBA’s Final Report on Greenwashing that addresses greenwashing risks in the banking sector and its impact on banks, investment firms and payment service providers. In the following sections, we will find out more on latest trends in greenwashing and EU regulations on countering greenwashing.
What are the trends in greenwashing in the financial sector?
We, as consumers and investors, assume that we can always trust financial institutions because they are one of the heavily regulated sectors. But, in recent years, trends show an alarming increase in alleged greenwashing incidents across the EU, with a notable rise in the financial sector. According to the EBA’s Final Report on Greenwashing, alleged greenwashing cases increased significantly between 2018 and 2022, around 206 cases reported in 2022 against 40 in 2018. In 2023, the EU financial sector accounted for 21% of the total alleged greenwashing cases involving companies established in EU. Moreover, the green loan market grew rapidly, reaching its peak in 2022 (EUR 294 billion in Europe and EUR 442 billion globally in 2022). These green loans with lower interest rates are granted to entities that meet certain Sustainable Performance Targets (SPTs) and Key Performance Indicators (KPIs). Unfortunately, some banks accepted weak SPTs and KPIs to achieve their Environmental, Social and Governance (ESG) financing targets. As a result, green loans have become the second biggest ESG debt market after green bonds.
What are the key regulatory frameworks on countering greenwashing?
The EU regulatory landscape has evolved to address greenwashing through various legislative measures. First of all, greenwashing can be captured by existing rules on ‘misleading marketing practices’ and ‘unfair commercial practices. The following are the main rules for marketing and commercial practices.
- The Unfair Commercial Practices Directive (UCPD) applies to unfair business-to-consumer commercial practices that materially distort the economic behavior of consumers. UCPD could be applied in relation to any financial services, including banking, investment, or payment services.
- The Directive on Markets in Financial Instruments (MiFID2) and its delegated acts contain rules on all information, including marketing communications. Under MiFID2, investment firms and credit institutions are required to assist clients to understand the concept of sustainability preferences and explain the difference between products with and without sustainability features in a clear manner and avoiding technical language.
- The Consumer Credit Directive (CCD1) and Mortgage Credit Directive (MCD) apply to consumer credit agreements and credit agreements secured by a mortgage, respectively. Under MCD and CCD1, a creditor, who are a natural or legal person that grants or promises to grant credit, are required to provide consumers with fair, clear and not misleading information prior and during the contractual phase, including marketing and advertising communications on sustainability features.
Secondly, greenwashing can be addressed through specific ‘sustainability-related requirements’. The following are the key sustainability-related regulations and directives.
- The EU Taxonomy Regulation (EU Taxonomy) establishes criteria to determine whether an economic activity qualifies as environmentally sustainable. It applies to financial market participants that offer financial products or corporate bonds. Under EU Taxonomy, financial market players bear reporting obligations concerning the proportion of environmentally sustainable economic activities in their business, investment, or lending activities.
- The Corporate Sustainability Reporting Directive (CSRD) ensures that investors and other stakeholders have access to the information they need to assess the impact of companies on people and the environment. Under CSRD, all large undertakings, or small and medium-sized undertakings with securities admitted to trading on the EU regulated markets are required to submit reports in accordance with European Sustainability Reporting Standards (ESRS).
- The Sustainability Finance Disclosure Regulation (SFDR) lays down harmonized transparency rules on how they integrate ESG factors into their investment decisions and financial advice and on their overall and product-related sustainability ambition. SFDR applies to all financial entities managing their clients’ funds through financial products, such as investment firms, institutions for occupational retirement provision, insurance intermediary, and credit institutions.
- The Capital Requirements Regulation (CRR2) and its implementing regulations lay down uniform rules concerning general prudential requirements and uniform formats and associated instructions for disclosures of information on ESG risks, including physical risks and transition risks.
- The Securitization Regulation (SR) lays down a general framework for securitization and establishes due-diligence, risk-retention and transparency requirements for parties involved in securitization. Its regulatory technical standards specify the content, methodologies, and presentation of information in relation to adverse impacts on the climate and other ESG-related impacts. SR applies to institutional investors and to originators, sponsors, original lenders, and securitization special purpose entities.
In short, the regulatory developments in the EU have laid the foundation for a sustainable finance and contribute to preventing, identifying and monitoring greenwashing. However, the above-mentioned frameworks are still being fully implemented and face certain challenges. We will explore the new rules and amendments to the existing regulations in the next section.
Where are we heading?
To bolster the fight against greenwashing, several amendments and new regulations are coming into force in the upcoming years. We will divide it into three categories: amendments to rules for marketing and commercial practices, changes to sustainability-related requirements and new regulations.
Regarding amendments to rules for marketing and commercial practices, the Directive on Empowering Consumers for the Green Transition (ECGTD) was adopted on February 28, 2024, and will be transposed into national laws by September 27, 2026. It amends the existing rules, namely UCPD and Consumer Rights Directive by prohibiting the use of generic environmental claims such as ‘environmentally friendly’, ‘eco-friendly’, ‘green’ and ‘climate friendly’. Furthermore, Retail Investment Package (RIS) was proposed by the European Commission on May 24, 2023. It is aimed at empowering retail investors by ensuring that they are treated fairly and duly protected. Under RIS, MiFID3 was adopted on February 28, 2024, and will be transposed into national laws by September 29, 2025. Also, CCD2 was adopted on October 18, 2023, and expected to be transposed into national laws by November 20, 2025.
In respect to amendments to sustainability-related requirements, the European Commission is currently carrying out a comprehensive assessment of SFDR, looking at issues such as legal certainty, usability and how the SFDR can play its part in tackling greenwashing. Moreover, CRR3 was adopted on May 31, 2024, and its amended provisions will become effective on January 1, 2025. CRR3 is aimed at strengthening the risk-based capital framework and enhancing the focus on ESG risks in the prudential framework.
In terms of new regulations, EU Green Bond Regulation (EuGB) which relies on the detailed criteria of the EU Taxonomy, was adopted on November 22, 2023, and will apply from December 21, 2024. EuGB lays down uniform requirements for issuers of bonds and provides optional disclosure templates for bonds marketed as environmentally sustainable to address integrity concerns associated with green debt. On May 24, 2024, the Corporate Sustainability Due Diligence Directive (CSDDD) was officially adopted, and the date of transposition has not been published yet. CSDDD lays down rules on obligations for companies regarding actual and potential human rights adverse impacts and environmental adverse impacts. It applies to all large EU and non-EU companies, including regulated financial undertakings.
In summary, on top of new regulations, most existing regulations have been amended or under assessment to further strengthen the measures to prevent greenwashing. It means financial institutions will have to adopt practices to mitigate greenwashing risks to comply with new and updated regulations.
Final remarks
In an era where sustainable finance is gaining prominence, greenwashing poses a substantial risk to the integrity and credibility of the financial sector in the EU. The current EU regulatory framework, including EU Taxonomy Regulation, CSRD, SFDR and CRR2, plays a critical role in setting the standards for transparency and accountability in sustainable financial products. These regulations mandate detailed disclosures and reporting on sustainability practices. In the upcoming years, the amendments to UCPD, MiFID2, CDD1 and CRR2 and the introduction of the EuGB and CSDDD are expected to further strengthen the regulatory environment and address the regulatory gaps in existing frameworks to counter greenwashing. As these regulations come into effect, financial institutions will be required to adopt more rigorous practices to align with the evolving sustainability-related requirements and mitigate the risks associated with greenwashing. Eris Law Advokatbyrå AB stands ready to assist financial institutions in navigating the complexities of sustainability-related requirements. Hence, in the next article, we will provide practical steps to comply with new regulations to counter greenwashing.
References:
EBA (2024) Final Report: Greenwashing Monitoring and Supervision. Available at https://www.eba.europa.eu/sites/default/files/2024-05/a12e5087-8fd2-451f-8005-6d45dc838ffd/Report%20on%20greenwashing%20monitoring%20and%20supervision.pdf.
EIOPA (2024) Advice to the European Commission on greenwashing risks and the supervision of sustainable finance policies. Available at c5d52866-1c3f-4913-9e20-5a5f40135efa_en (europa.eu).
ESMA (2024) Final Report on Greenwashing. Available at ESMA36-287652198-2699_Final_Report_on_Greenwashing.pdf (europa.eu).
Sato M, Gostlow G, Higham C, Setzer J, Venmans F (2023) Impacts of Climate Litigation on Firm Value. Available at working-paper-397_-Sato-Gostlow-Higham-Setzer-Venmans.pdf (lse.ac.uk)
Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting. Available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32022L2464
Directive (EU) 2023/2225 of the European Parliament and of the Council of 18 October 2023 on credit agreements for consumers. Available at https://eur-lex.europa.eu/eli/dir/2023/2225/oj
Directive (EU) 2024/790 of the European Parliament and of the Council of 28 February 2024 amending Directive 2014/65/EU on markets in financial instruments. Available at https://eur-lex.europa.eu/eli/dir/2024/790/oj
Directive (EU) 2024/825 of the European Parliament and of the Council of 28 February 2024 amending Directives 2005/29/EC and 2011/83/EU as regards empowering consumers for the green transition through better protection against unfair practices and through better information. Available at https://eur-lex.europa.eu/eli/dir/2024/825/oj
Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitization. Available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32017R2402
Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements. Available at https://eur-lex.europa.eu/eli/reg/2019/876/oj
Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector. Available at https://eur-lex.europa.eu/eli/reg/2019/2088/oj
Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088. Available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32020R0852
Regulation (EU) 2023/2631 of the European Parliament and of the Council of 22 November 2023 on European Green Bonds and optional disclosures for bonds marketed as environmentally sustainable and for sustainability-linked bonds. Available at https://eur-lex.europa.eu/legalcontent/EN/TXT/?uri=celex:32023R2631
Regulation (EU) 2024/1623 of the European Parliament and of the Council of 31 May 2024 amending Regulation (EU) No 575/2013 as regards requirements for credit risk, credit valuation adjustment risk, operational risk, market risk and the output floor. Available at https://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX%3A32024R1623
Commission Delegated Regulation (EU) 2021/1253 of 21 April 2021 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms. Available at https://eur-lex.europa.eu/eli/reg_del/2021/1253/oj
Commission Delegated Directive (EU) 2021/1269 of 21 April 2021 amending Delegated Directive (EU) 2017/593 as regards the integration of sustainability factors into the product governance obligations. Available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32021L1269
Commission Delegated Regulation (EU) 2021/2178 of 6 July 2021 supplementing Regulation (EU) 2020/852 of the European Parliament and of the Council by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of Directive 2013/34/EU. Available at https://eur-lex.europa.eu/eli/reg_del/2021/2178/oj
Commission Delegated Regulation (EU) 2023/2772 of 31 July 2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards. Available at https://eur-lex.europa.eu/eli/reg_del/2023/2772/oj
Commission Implementing Regulation (EU) 2022/2453 of 30 November 2022 amending the implementing technical standards laid down in Implementing Regulation (EU) 2021/637 as regards the disclosure of environmental, social and governance risks. Available at https://eur-lex.europa.eu/eli/reg_impl/2022/2453/oj