Greenwashing enforcement not a matter of if but when

Financial institutions have created and sold products that are intended to meet the booming demand for environmentally responsible and sustainable investments.

PwC reported in October 2022 that environmental, social and governance-related assets under management had already reached $18.4tn (£14.4tn) in 2021 and may hit $33.9tn by 2026. That is a huge market. It makes sense that most financial institutions have sought to participate.

And when marketing these products, there has been an incentive to emphasise their positive ESG credentials. With investors looking for ‘green’ products, it is natural to seek to persuade them that your product is the best on the market.

But the lack of clear standards and definitions on what it means to have positive ESG credentials causes a real problem.

If a product has been marketed as ‘green’ or ‘sustainable’, but there are no clear and coherent standards as to what that means, there is a risk that regulators will decide the terms have misled customers.

Regulatory intervention

Regulators have shared the worry that ESG terminology needs to be accurately defined. Both consumer and institutional clients need clarity to understand what they are buying.

In response, the EU has introduced the sustainable finance disclosure regulation and a taxonomy regulation. In the US, the Securities and Exchange Commission has proposed its own rule changes to require climate-related disclosures.

And here in the UK, the Financial Conduct Authority has consulted on sustainability disclosure requirements and a green taxonomy to be implemented in the near future.

These global regulatory changes bring their own problems. With multiple regimes to comply with, financial institutions will need to work out how to meet the requirements of all the jurisdictions in which they operate.

Aligning with multiple regulatory regimes will not be straightforward.

In trying to provide investors with what they wanted, asset managers might be deemed to have overstated their cases.

Although the FCA said in its consultation paper that it has taken account of the EU and US plans, it acknowledged that precise requirements will differ, noting for example “that our entity-level disclosure requirements are not fully aligned with the EU SFDR requirements or US requirements for fund advisers”.

The upshot of all this is an acute risk of enforcement action.

In the US, the SEC has not waited for its specific proposals to be implemented before acting.

In May 2022, it found that BNY Mellon Investment Adviser had “represented or implied in various statements that all investments in the funds had undergone an ESG quality review, even though that was not always the case”.

And in October 2022 it found that Goldman Sachs Asset Management “had several policies and procedures failures involving the ESG research its investment teams used to select and monitor securities”.

Both institutions settled their cases, receiving fines of $1.5mn and $4mn respectively.

These sound like the type of mis-selling allegations that are causing banks to worry.

Here in the UK, the FCA could choose to follow suit. Although it proposes to introduce a broad anti-greenwashing rule, it acknowledges that this will merely clarify and re-state an existing rule: where a regulated financial institution communicates with its customers, it must do so in a way that is clear, fair and not misleading.

Any promotion of a financial product as ‘green’ needs to have complied with that standard.

Institutions are therefore understandably worried that they could be accused of greenwashing in respect of products marketed before the new, more specific rules are implemented.

In trying to provide investors with what they wanted, asset managers might be deemed to have overstated their cases.

This is already happening in other jurisdictions. Regulators in the US and Germany are investigating whistleblowing allegations that German fund manager DWS may have marketed its funds as greener than they were, thus misleading investors. DWS denies the allegations.

Even if an enforcement investigation does not end with an adverse finding, cooperating with a regulator running an investigation is time and resource-consuming.

Compounding the concern for banks and asset managers, greenwashing will not need to have been deliberate to attract regulatory scrutiny. In fact, given the ambiguity around the use of green terminology, inadvertent greenwashing is the more likely problem.

What a firm meant and what an investor understood could be different in a field that is both vague and continually evolving. But if there is a mismatch between a product’s credentials and what a regulator thinks an investor would understand those credentials to mean, enforcement action will follow.

And even if an enforcement investigation does not end with an adverse finding, cooperating with a regulator running an investigation is time and resource-consuming.

Legal and compliance professionals at financial institutions are expecting that they will have to allocate time to regulators looking into past ESG statements even if they believe such statements were defensible.

There is a concern that the FCA could scrutinise past ESG statements with 20-20 hindsight. It is possible that judgements as to what ESG statements meant in the past might be measured against newly clarified standards.

And the worry does not end there. Regulatory action often leads to private litigation.

When regulators around the world responded to the FX and Libor scandals, they issued large fines and made lengthy adverse findings. The fallout from those findings continues. To this day, affected banks are still engaged in follow-on litigation brought by aggrieved clients.

When the wave of enforcement action over greenwashing arrives, we can expect those who believe they were mis-sold the associated products will seek redress.

It seems that it is not a question of if but when we see greenwashing enforcement actions and litigation in the UK.

Matt McCahearty is a partner at Macfarlanes