Russia’s invasion of Ukraine and the ensuing energy crisis have forced some countries to introduce transitional measures that may give the impression of slowing efforts to consolidate sustainable finance. However, this highly complex environment has not prevented the domestic market from maintaining the trend of previous years, based on assets managed under sustainability criteria. Specifically, green loans, together with those linked to projects of a clearly sustainable nature, and loans linked to sustainability indicators, totalled €32.631 billion in Spain in 2022, an increase of 64% according to the data available from the Spanish Sustainable Finance Observatory.
European regulation also helped to boost transparency and investor confidence in 2022. On the one hand, the Corporate Sustainability Reporting Directive (CSRD) was adopted, aiming to improve the information available to market participants and supervisors. This initiative seeks to strengthen and standardise non-financial reporting requirements for more than 50,000 companies operating in Europe, including large companies and listed medium-sized companies with more than 250 employees, although simpler standards will be developed for the latter. In fact, at the end of 2022 the European Financial Reporting Advisory Group (EFRAG) approved updated versions of the European Sustainability Reporting Standards (ESRS), which will facilitate detailed corporate reporting based on harmonised, comparable, high-quality datasets, with independent audits and certification processes. On the other hand, for customers, the Markets in Financial Instruments Directive (MiFID II) was also approved, incorporating questions for clients to define their preferences regarding sustainable financial products, which has led banks to make a considerable effort among their staff to adequately meet their clients’ needs.
From a risk management perspective, the European Central Bank (ECB) published the results of the climate change risk management Thematic Review, showing, among other points, that most institutions rely excessively on proxies to quantify their clients’ emissions due to a lack of granular information to manage climate risks. Even so, the ECB’s assessment showed that 85% of European banks have basic practices in place for identifying, managing and governing the physical and transition risks presented by their clients, although they should move forward in developing more sophisticated methodologies. In any case, the ECB expects institutions to have incorporated supervisory expectations by the end of 2024.
However, none of this has reduced concerns about highlighting the importance of disclosure and transparency in the financial decisions of investors willing to contribute to a decarbonised economy. For this reason, in May 2022, the European Commission requested input from the three European Supervisory Authorities (ESAs) in the form of a diagnosis of this phenomenon, which the authorities themselves defined as the set of market practices on sustainability disclosure that do not adequately reflect the sustainability risks and impacts associated with an issuer or financial instrument.
However, it was not until COP27 that the concern of institutions and international regulators about greenwashing was brought to the fore through an article endorsed by the United Nations High-Level Expert Group, Integrity Matters, which questions whether the climate commitments voluntarily put forward by companies and financial institutions are sufficiently credible. According to these experts, the growth in commitments made by the private sector has been accompanied by a proliferation of criteria and benchmarks for setting net-zero commitments with varying levels of robustness and rigour, which may ultimately undermine investor confidence.
In November 2022, the European supervisory authorities launched a consultation with all stakeholders with the aim of improving understanding of the concept, bringing greenwashing back to the centre of the debate. The possible cases of this phenomenon essentially stem from four factors: ambiguity of the concept, the role of market participants, the different standards used to address disclosure, or the lack of adequate information. When these factors combine, the outcome is even more complex, making it necessary to delimit this risk through a consensual and understandable definition, resilient to unforeseen events such as the war in Ukraine or the deterioration of economic conditions, which enables companies to adapt to new contexts without being penalised or accused of greenwashing. Therefore, an initiative such as the one proposed by the supervisory institutions would not be considered appropriate if it focused solely on the financial sector, as it would lose effectiveness and comprehensiveness.
In contrast to this way of understanding the problem, the regulatory framework designed for the development of sustainable finance in the EU must be completed and allowed to mature before considering a new set of rules that would make the landscape more complex. In fact, at some point, the pieces of this regulatory mechanism will begin to adjust, and strict regulatory enforcement will leave little room for non-compliance, so the objectives pursued by the European Commission’s Sustainable Finance Action Plan will emerge naturally.
Likewise, it is essential that the concept of greenwashing be limited to acts involving gross negligence in complying with a given regulation, or that reflect a certain intent to be non-compliant. In any case, it would be important to accept that the long-term voluntary commitments undertaken by the financial institutions leading this transformation are not only leveraged on solid global frameworks and standards, but are also subject to evaluation and scrutiny by internationally recognised organisations such as UNEP-FI (United Nations Environmental Programme Financial Initiative) or GFANZ (Glasgow Financial Alliance to Net Zero), and therefore the targets set by these institutions should not be viewed with distrust.
Avoiding collateral damage
Considering that pressure against greenwashing tends to focus, paradoxically, on those companies that most transparently show their decarbonisation plans, this scrutiny of greenwashing could generate two negative side effects. On the one hand, an exit effect, especially given the duration of the commitment, the diversity of actors involved and the complexity of the geopolitical context we are currently anticipating. An impact that would mean ceasing to contribute to previously announced climate commitments. Therefore, it would be desirable to work more on creating the right incentives for compliance. On the other hand, a silent effect, which has been coined as green hushing to avoid accusations of greenwashing, meaning that climate commitments remain in place but financial institutions would stop giving them public visibility. In any case, these effects are counterproductive and could lead to a pause in the ambition of financial institutions to combat the effects of climate change.
In short, it is essential to protect financial institutions from unfounded accusations of greenwashing, as these increase reputational risks and affect the level of confidence in financial markets. Therefore, despite obstacles linked to an inadequate lack of data or incomplete and sometimes inconsistent regulation, the financial sector is sensitive to the reputational risk posed by pressure to avoid greenwashing. Accordingly, the best way to move forward without the risk of slowing the progress of sustainable finance is to base financial decisions on high-quality data, comparable across companies and aligned with a predictable, consistent and unambiguous regulatory framework.
