As fund managers and investors across the 27 countries in the European Union continue to question the union’s approach to its sustainable finance framework, Brussels has made clear it will take its time before addressing growing confusion over greenwashing. “Greenwashing remains to be defined at the EU level.”
The industry has flagged widely that the current EU policy approach and a lack of formal guidance on how to interpret regulations has raised the reputational risk of “greenwashing”, which could be defined as the process of conveying a possible false impression with financial products.
EU financial supervisors acknowledge they’re looking into these issues. The European Commission will only start considering them after May 2024, once it has received feedback from the three EU’s financial supervisory authorities, known as the ESAs.
One national regulator familiar with the work of sustainability finance specialists at the European Securities and Markets Authority, ESMA, has told Investment Officer that the experts have established a need to formulate a legal definition of what is “greenwashing” and what is not.
‘Polymorph’
“Greenwashing remains to be defined at the EU level,” the person said. “It is really something that is polymorph, hard to define. It’s difficult to define a framework that addresses these issues.”
The EU so far has remained vague about such a definition. The European Commission, in a letter sent last New Year’s eve, explicitly stated that natural gas and nuclear energy are still to be considered as sustainable sources of energy as defined in the widely discussed EU taxonomy for sustainable finance. Since February, Russia’s war against Ukraine has diminished pressure on Brussels to amend this approach.
Meanwhile, a lack of central EU guidance on what is sustainable and what is not is leading to a fragmented approach in Europe. Some national regulators, including the Dutch AFM, have adopted a more stringent approach than counterparts in other EU countries. As a result, fund managers have to navigate different interpretations of EU rules in different countries. Regulators fear some look for regulatory arbitrage opportunities.
Framework not yet ready
Investors, fund managers and data specialists in recent months have all expressed their doubts about the way the EU’s sustainable finance framework is introduced. It consists of a mix with the EU Taxonomy, various MifidII requirements, the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD), due to enter into force from 2024. Those that see merit in the approach agree that it can only be successful in the long-term, once all interacting measures have been put in place.
So far, various components have yet to be aligned. Under the SFDR, funds can only be considered sustainable if they invest in companies with sustainable products and services or companies whose products have a positive impact. But while criteria for such funds have been set, reliable data on corporations is rarely available given that CSRD has yet to enter into force. Only then, companies are required to post sustainability data that funds can use.
The financial industry also appears to have been overwhelmed by popular demand for sustainable investment products. Research published recently by Morningstar shows that more than half of all investment funds in Europe now are classified as sustainable under the SFDR, even though many of them only hold a relatively small part of their investments in sustainable companies. Light-green “Article 8” SFDR funds, for example, typically held between 10 and 20 percent of their investments in sustainable companies during the second quarter, Morningstar data shows, and, as per the European Commission, natural gas and nuclear energy, is allowed to be considered sustainable as a “transition” fuel.
EC requested ‘input’ on greenwashing
Asked for a formal response to the current EU discussions, a spokesman for ESMA said that the three European supervisory authorities, which also includes the bodies for banking, EBA, and for pensions, Eiopa, have been asked by the European Commission to provide feedback on “greenwashing issues” in the shape of a “request for input”.
This request foresees two deliverables. The first will be a progress report, due by the end of May next year. The final report is to be delivered in May 2024, said the spokesman. Each supervisory body is due to provide its own input on greenwashing risks and occurrences and on the supervisory actions taken and challenges faced to address those risks.
The input needs to be provided “individually but in a coordinated manner”, the European Commission’s request to the supervisors said. Supervisors are to address “several aspects related to greenwashing and its related risks as well as the implementation, supervision and enforcement of sustainable finance policies aimed at preventing greenwashing.” it said.
The ESMA spokesman said that discussions with the other supervisors have started, but that these are not designed to provide a legal definition of greenwashing, although “they might provide useful input to the EC” when it comes to “understanding and defining the greenwashing phenomenon”.
EU approach’s adequacy to be assessed
The reports by the supervisors are also due to assess the EU response’s “adequacy from the practical and legal standpoints”, according to the Commission.
So a lack of clarity on greenwashing risks is an issue that the industry will have to contend with for the foreseeable future. Regulators and policymakers have already urged the sector to be careful.
Claude Marx, director-general of Luxembourg’s financial supervisor CSSF, said regulators fear that some industry participants are looking for “regulatory arbitrage” opportunities, seeking to benefit from differences in the way rules are applied in different countries. “Avoiding this is one of the goals of authorities,” he said at an ALFI conference in March.
Patrick de Cambourg, chairman of the EU Financial Taskforce on Sustainability Reporting Standards, has advised asset managers to be “very careful” when preparing sustainable funds. “The biggest challenge for asset managers is to avoid being accused of greenwashing or ESG washing,” De Cambourg said at a Paris conference. “Sometimes the border between a fair and neutral explanation of what you do, and marketing yourself as a green product or a socially responsible product, is seen.”