the assurance approach to managing fraud

An assurance approach is where the assurance teams come together in the running of the fraud risk program of a company. Just as fraudulent activities cut across different departments of a company, assurance teams also need to come together to pool their knowledge in curbing them. The ACFE Report to the Nations notes that nearly half of all occupational fraud comes from these four departments: Operations 15%; Accounting 12%; Executive/Upper Management 11% and Sales 11% (The ACFE, 2022). This spread further justifies the need for an assurance approach to the fraud risk management program.

While the Internal Control team or the Operational Risk team might take a lead on managing the program, other assurance teams such as the internal audit, cyber security and even the compliance teams need to be involved and this starts as early as the fraud risk assessment. For a robust fraud risk assessment, these teams who have different views of the company’s control gateways should contribute where and what to check, where and what to ask, what to expect and what the company might be most susceptible to. This sometimes might not even be from their experience within the company but from their interactions with peers and professional colleagues. The coming together of these thoughts translates into a more robust fraud risk management program and controls.

a note of caution

Reports and reviews should however be shared across these teams with necessary briefings and suggestions passed around when needed. And this does not need to wait till certain fixed times, it should be instituted as an ongoing as-need-be exercise. The Institute of Internal Audit (IIA) auditing standards (The IIA, 2022) have also recently started advising that the Internal Audit team always consider fraud risks in their reviews.

There is never a foolproof fraud risk management approach that guarantees zero fraud cases. The assurance approach to fraud risk management, however, gives far more assurance of cover compared to a standalone or siloed approach.

References

“Occupational Fraud 2022: A report to the Nations.” Association of Certified Fraud Examiners. https://legacy.acfe.com/report-to-the-nations/2022/

“The IIA Releases Updated Practice Guide on Assessing Fraud Risk Governance and Management.” The Institute of Internal Auditors. May 2022: https://www.theiia.org/en/content/communications/2022/may/the-iia-releases-updated-practice-guideon-assessing-fraud-risk-governance-and-management/ peer-reviewed by

Carl Densem

Author

Dami Osunro

Dami Osunro is a Risk Management and Audit professional with a little over ten (10) years of experience cutting across external audit, internal audit, investigations and risk management. His experiences cut across banks, consulting services and investment managers.

Dami holds professional qualifications such as the Certified Fraud Examiner (CFE), Certified Risk & Information Systems Control (CRISC), Certified Information Systems Auditor (CISA) and a Certified Business Continuity Professional (CBCP). He holds a Msc in Corporate Finance and a Bsc in Economics.

He is currently a Senior Analyst, Operational Risk Management with the Enterprise Risk Management team at Alberta Investment Management Corporation (AIMCo).

Greenwashing presents a tempting alternative for companies struggling to meet evolving ESG regulatory standards and consumer preferences. This article examines the pitfalls of Greenwashing and the very real regulatory, legal, financial, and reputational implications organizations may face if they fail to safeguard against unsound or half-measured ESG practices.

knowing the unknown – the stain greenwashing leaves on financial institutions

by Ina Dimitrieva

The word Greenwashing is omnipresent. In almost every discussion on sustainable finance and related ESG risks it is considered an important issue, and its prevention and tackling are prioritized by financial regulation authorities such as the European Securities and Markets Authority (ESMA) and Securities Exchange Commission (SEC). Recognized as an emerging risk by the European Banking Authority (EBA)1, Greenwashing and its prevention will be a key objective in the organization’s sustainable finance roadmap in coming years.

It is becoming increasingly obvious that Greenwashing poses a huge risk to the efficiency and integrity of efforts to achieve sustainability goals. It appears like an external phenomenon, floating above all— yet deep in the background at the same time. The term is, however, so generic and abstract that it is barely included in the definitions of regulatory guidelines or technical standards. Nor is it included structurally in the classification and methodological concepts of measuring and monitoring ESG risks.

how are we going to prevent it, if we do not define it?

In simple words, Greenwashing means to present activities as green and sustainable when they are not. In this sense, Greenwashing can be intentional and unintentional. Typical examples of Greenwashing in the financial industry are:

• Making misleading claims on green bond investments through self-labeling with no guarantee of proceeds meeting sustainability-eligible criteria

Granting green mortgages to finance buildings with low energy efficiency

• Touting long-term commitments to climate goals (e.g. achieving Net Zero) while at the same time sustaining the short-term continuation of business as usual by lending to the fossil fuel sector and related industries

Other less widely-used terms related to Greenwashing are Bluewashing, which describes misleading claims of companies on social matters (e.g. human rights), and SDG-washing, which stands for businesses that claim to be aligned with the Sustainable Development Goals (SDGs) set by the United Nations without taking action for a meaningful contribution to the achievement of these goals. This becomes apparent when companies focus on goals that are easily achievable (rather than prioritizing goals with high impact) or by focusing only on positive impacts and neglecting related trade-offs 2 .

The preconditions and incentives for Greenwashing are fostered due to increasing expectations on companies to communicate about sustainability issues. Being silent about them is also not an option. This practice, known as Greenhushing, is even less transparent and more harmful than Greenwashing 3, which is why the latter becomes a probable event.

From regulatory and risk management perspectives, Greenwashing falls into the same category as misconduct, fraud, corruption, tax evasion, and money laundering. However, its distinguishing characteristic lies in its fundamentality for all ESG risks and not only in being part of them. The negative effects of Greenwashing go beyond legal risk and the associated litigation costs, especially when the concept of Double Materiality is applied. The transmission channels of Greenwashing are multidimensional and affect all risk types.

Operational Risk

The risk of Greenwashing emerges within the scope of operational risk, when there are no practices to identify it, or they are inadequate due to lack of knowledge or misconduct. When relying on false or bad quality data provided by external counterparties, financial institutions unconsciously run the risk of misleading about their sustainable activities. Also, the lack of internal control mechanisms regarding Greenwashing prevention allows for intentional misconduct and fraud by employees, if for example their remuneration is linked to “green” market activities (which is encouraged by regulators). It is also possible to mislead investors, when sustainable investments cannot meet the eligibility criteria provided in pre-contractual disclosures.

Credit Risk

Greenwashing can lead to underestimated ESG risks. A distorted picture of the environmental impact of investments increases unexpected losses if transition and physical risks materialize. Counterparty financial situations, and even solvability, can be significantly harmed, which should be reflected in the estimation of credit risk parameters such as Probability of Default (PD) and Loss Given Default (LGD).

The potential threat of Greenwashing increases market credit spreads and should be considered in Credit Value Adjustments (CVAs).

Market Risk Liquidity Risk

Similar to the credit risk channel, assets that have been affected by Greenwashing can significantly lose market value and even become stranded, so they cannot be sold. This uncertainty should be reflected in the market risk parameters such as Value-at-Risk (VaR). For example, DWS, the second-largest asset management company in Europe saw its share price lose 13.7% of its value after accusations of misleading claims on its ESG-related Assets under Management (AuM), which also caused a share price fall for its parent company, Deutsche Bank4. Investments in companies or bonds, which are uncertain in terms of meeting sustainability-eligible criteria, might significantly impact the current market value of asset portfolios.

If Greenwashing risk materialises (i.e. the activities claimed as sustainable are suspected not to be), some investors may withdraw their funds, which could lead to liquidity shortage and increased funding costs. Companies involved in Greenwashing will not be able to attract funds easily, which will be reflected in higher liquidity spreads for their issuances on the capital markets and may impact the liquidity of other related companies acting on the same market and the same industry. On the money market, it is possible that securing roll-overs of continuous short-term funding might also be impacted in terms of price and quantity.

On the asset side of liquidity, stranded assets impacted by Greenwashing become less liquid on the market. The respective effect on liquidity buffers and liquidity ratios, such as Liquidity Coverage Ratios (LCRs) and Net Stable Funding Ratios (NSFRs), should not be underestimated as the ability of banks to meet regulatory requirements might be impacted as well. Becoming entangled in such a course of events can lead to further bad press for a company’s standing.

Reputation Risk

The reputation of the financial institution may be harmed by Greenwashing related to negative image among stakeholders. The effects are not linear and can be associated with significant costs of re-building the brand and the image on the market. A prominent case was the Volkswagen scandal of cheating emissions testing. The brand’s stock has still not recovered since it was damaged back in 20155. With growing awareness and commitment towards sustainability within the financial services industry failing to meet public expectations, Greenwashing practices—or even accusations of it—will become even more risky for a company’s reputation.

When a Greenwashing practice is identified, financial institutions may be challenged by legal claims of investors and environmental activists. The risk then materializes through increased litigation costs. Even lacking direct criminalisation of Greenwashing under the current law in Europe, regulations on consumer protection and fair competition allow for legal action against misleading sustainability claims. In the United States the Federal Trade Commission can investigate companies’ environmental marketing claims under the so called “Green Guides.” Settlement costs are usually between 1% and 15% of a company’s profits, and several non-financial corporates already paid millions of USD with one of the highest being $21 million by Fairlife LLC6

Greenwashing is a huge threat for fulfilling regulatory expectations on the management of ESG risks and meeting sustainability goals. The risk of becoming non-compliant is connected with possible regulatory sanctions such as penalizing factors or increased capital requirements. Financial regulators around the world have strengthened requirements on sustainability disclosures by market participants, which increases the regulatory risk of Greenwashing due to the obligatory nature of external reporting.

With the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD) regulatory authorities, Europe is leading the way in the supervision of Greenwashing activities. Upon request by the European Commission (EC), the European Supervisory Authorities (ESAs) have launched an industry-wide survey on key aspects and risk exposures associated with Greenwashing and related market practices7 .

Thus, the European regulators are assessing the need for amendments to the EU supervisory framework and the EU single rulebook8. The main purpose is to identify, prevent, investigate, sanction, and remediate Greenwashing in the financial market. It is therefore expected that new supervisory measures will follow, including assessments of mandatory disclosures, investigations, and formal enforcement actions such as sanctions or other administrative measures.

Legal Risk Regulatory Risk Conclusion

Given the multidimensional and complex nature of Greenwashing, it cannot be left on the sidelines of internal risk management. Underestimation of its potential impact on the major risk types leads directly to undercapitalization of such risks.

Moreover, the main responsibility of tackling Greenwashing should not be driven solely by regulatory authorities. It should primarily be prevented and managed by financial institutions and their customers.

To increase awareness and accountability, Greenwashing should be integrated as a separate risk category or risk factor. It should be included on a stand-alone basis in the risk management and prudential regulation framework. It should be explicitly considered in all three Pillars of the Basel framework as a minimum standard. Once this bottom line is safeguarded, the learning curve in ESG risk management will become clearer—and risk mitigation and steering more effective.

References

1. EBA. “The EBA publishes its roadmap on sustainable finance”, Press release, 13 December 2022, available at https://www.eba.europa.eu/eba-publishes-its-roadmap-sustainable-finance

2. Dinter, L. “5 Tips to avoid SDG washing”, 7 October 2021, https://sustainlab.co/blog/check-out-our-five-tips-to-avoid-sdg-washing-and-make-sure-your-company-achievesa-real-positive-sustainability-impact

3. World Economic Forum. “What is ‘greenhushing’ and is it really a cause for concern?”, 18 November 2022, available at https://www.weforum.org/agenda/2022/11/what-is-greenhushing-and-is-it-really-a-cause-for-concern/

4. Azzouz, M. “Greenwashing allegations are jolting the financial industry: heightened needs for cautiousness, integrity and guidance”, 30 September 2021, available at https://gsh.cib.natixis.com/our-center-of-expertise/articles/greenwashing-allegations-are-jolting-the-financial-industry-heightened-needs-for-cautiousness-integrity-and-guidance

Schiftler, A. “DWS and the Global Crackdown on Greenwashing”, published on Morningstar, 19 September 2022, available at https://www.morningstar.co.uk/uk/news/226564/dws-and-the-global-crackdown-on-greenwashing.aspx

5. Learnsignal. “The Volkswagen Emissions Scandal: A Comprehensive Overview”, 2020, https://www.learnsignal. com/blog/volkswagen-emissions-scandal-overview/#:~:text=The%20Volkswagen%20emissions%20scandal%20 had,reputation%20for%20honesty%20and%20integrity

6. Washington Legal Foundation. “Greenwashing litigation disincentivizes adoption of ESG values”, 10 August 2022, available at https://www.wlf.org/2022/08/10/wlf-legal-pulse/greenwashing-litigation-disincentivizes-adoption-of-esg-values/

7. EBA. “ESAs launch joint Call for Evidence on greenwashing”, Press release, 15 November 2022, available at https://www.eba.europa.eu/esas-launch-joint-call-evidence-greenwashing

8. EBA. “The EBA publishes its roadmap on sustainable finance”, Press release, 13 December 2022, available at https://www.eba.europa.eu/eba-publishes-its-roadmap-sustainable-finance