How do we stop the spin cycle? The role of regulation in tackling greenwashing
This blog has been informed by discussions with the A4S Expert Panel as well as the insights A4S accesses through our extended networks and technical experience. We would like to thank members of the Expert Panel for their contributions.
This is the second part of our greenwashing series. Read our first greenwashing blog to see what greenwashing is, why it happens and the impact it has.
Setting the standard – the role of regulation and where we are today
Consistent and comparable sustainability reporting has – arguably – an important role to play in addressing greenwashing, alongside a shared and transparent approach to financial product labelling. Advocates of regulation suggest that it can help to mandate sustainability disclosure and product labelling, making reports and product labelling standardized and user friendly.
“Regulation … plays a key role in setting standards for [financial] product disclosures to ensure that information provided to consumers is not misleading and can be compared across different financial products.” – Will Oulton, Chair of Eurosif, Non Exec Director, and Sustainable Investment Expert
Some sustainability disclosure frameworks and standards that aim to provide consistent and comparable reporting standards and combat greenwashing already exist, as do financial product regulations and requirements – and even more are currently being proposed. For example:
- Under the EU’s Corporate Sustainability Reporting Directive (CSRD), approximately 50,000 companies will be required to report on their sustainability performance.
- The Securities and Exchange Commission (SEC) in the US has issued climate-related disclosure requirements for SEC-registered companies.
- The EU Sustainable Finance Disclosure Regulation (SFDR) requires financial market participants to disclose how sustainability factors are integrated at an entity and product level.
- The UK Sustainability Disclosure Requirements (SDR) requires financial market participants to disclose sustainability information, including in relation to product labelling.
- In China, new reporting requirements will adopt a ‘double materiality’ lens and are being issued by Shanghai Stock Exchange (SSE), Shenzhen Stock Exchange (SZSE), and Beijing Stock Exchange (BSE).
Voluntary industry initiatives can also help organizations avoid greenwashing – although, as happened with the GRI standards, TCFD framework and the IFRS sustainability standards, initiatives that start out being voluntary may be adopted later by regulators. For this reason, paying attention to industry reporting initiatives can give organizations a sense of disclosures that may be required in the future.
Initiatives that are currently voluntary include the Taskforce on Nature-related Financial Disclosures (TNFD) recommendations, the Sustainable Development Goals Disclosure Recommendations, and the sustainability metrics and disclosures published by the World Economic Forum.
The limitations of regulation
One of the main concerns raised is that there can be a disproportionate amount of focus on regulating disclosures rather than driving action. This could undermine more direct and material sustainability efforts – including work to reduce global greenhouse gas emissions. With sustainability data systems and controls at a relatively immature stage, particularly for scope three disclosures, this risk is real. Regulators should therefore look more broadly, considering the full scope of regulatory tools at their disposal for tackling greenwashing and sustainability challenges. This can include holding organizations to account for their actions and transition plans.
Some critics also argue that mandatory approaches can make greenwashing worse rather than better if a high enough standard isn’t adopted.
Regulators can face pressures from industry to ease disclosure rules and provide more flexibility for reporting organizations, something that is of particular concern to NGOs. If regulators water down disclosures – whether because of industry pressure or for other reasons – an environment is created in which companies can meet disclosure standards without necessarily delivering the large-scale change and impact that is needed. This is a particular problem as report users may see reporting standards and frameworks as a badge of quality, even if this doesn’t hold up to more detailed scrutiny.
“Without tangible reductions in emissions or increases in biodiversity then the scale of action now reported across business is always going to be labelled, at least partly or on average, as greenwash.” – Aled Jones, Director, Global Sustainability Institute, Anglia Ruskin University
When combined with the increased number of standards and frameworks in use globally, a growth in regulation creates complexity that could intensify the risk of greenwashing. More regulation means that multinational corporations will need to navigate an ever-wider range of disclosure and labelling requirements across the countries in which they operate. While the International Sustainability Standards Board issued the IFRS Sustainability Disclosure Standards – supported by A4S – with the aim of establishing a global baseline for sustainability reporting, harmonization must be a continued area of focus over the coming years.
Getting the balance of disclosures right can also be a challenge. Regulators need to ensure that the incentives created by the required disclosures will focus organizational time on the right things. Disclosures that are unrealistic, immaterial or focus on the wrong things can undermine the credibility of any reporting framework.
Finally, yet most importantly, regulation itself is rarely enough – it needs teeth to be meaningful. There need to be consequences for greenwashing.
Consequences
Organizations found to have made misleading environmental claims can face censures, fines, reputational damage and the loss of sustainability certifications. They may be forced to remove adverts or take products off the market. The extent to which these penalties are likely to change behaviour will depend on the value of the fines, the expected commercial repercussions for organizations, and the overall social and political climate. In many jurisdictions, regulators have been cracking down on greenwashing, and this trend seems likely to continue.
The proposed Green Claims Directive from the European Commission introduces tighter rules for greenwashing, backed by penalties. Euractiv reports that the penalties will range from “fines to confiscation of revenues, and temporary exclusion from public procurement processes and public funding.”
In the UK, the Competition and Markets Authority (CMA) Green Claims Code, published in 2021, provides guidance for organizations on how they can make environmental claims in line with consumer protection law. However, the authority has historically had limited powers of enforcement. A new Digital Markets, Competition and Consumers Bill – expected to come into force in 2024 – will give the CMA new enforcement powers. These powers would include fines of up to 10% of an organization’s global turnover.
The US is clamping down too. Asset manager DWS agreed a US$25 million settlement with the SEC, of which US$19 million associated with misstatements relating to its ESG investment process.
The Australian Securities and Investments Commission started legal action against three funds in 2023. In one of these cases, a settlement of A$11.3 million has been agreed but is yet to be formally approved by Australia’s federal court.
South Korea has become the first country in East Asia to draft a greenwashing law that is backed by financial penalties, with fines of up to ₩3 million (US$2,271). Although the absolute value of the fine is low, it marks a turning point in approaches to greenwashing within the region.
Consequences for businesses may go beyond the direct cost of financial penalties, though. One recent study has found a link between climate litigation and a drop in share price. The impact was relatively minor, but it is an indication that climate action against a company is regarded poorly by markets as well.
What next?
All organizations need to familiarize themselves with the requirements of relevant regulations – and other voluntary commitments that they have made – and ensure that they have systems, processes and controls in place to meet them. Finance professionals have a key role to play in helping organizations avoid greenwashing – and its financial consequences. The next part of our greenwashing series will explore finance’s role and the actions that finance professionals can take.
* Several other countries, included Taiwan, Morrocco, Jordan, Egypt, Zimbabwe and Columbia, also have mandatory GRI reporting requirements.
Further information
Register interest in our ESRS workshops, which focus on some of the key concepts of the EU CSRD and ESRS. Our next A4S Sustainability Reporting Workshop – ESRS takes place on 16 April 2024 in Cologne, Germany.
For more sustainability reporting guidance, check out our Navigating the Reporting Landscape guide and our Sustainable Reporting Insights series.
