Regulatory trends and “greenwashing”

2.5 Regulatory trends and “greenwashing”

Momentum has been building, particularly in the UK and the EU, around integration of climate risk into regulatory regimes. This has helped to build an understanding around climate risk across the finance industry which is now expanding towards wider environmental and social themes. Integrating these wider externalities into financial risk management is forcing firms to change the way they think about and measure risk, and ultimately factor it into pricing models and capital holdings. This creates further incentives for firms to develop sustainable finance products with lower risk weights.

Growth in sustainable finance products has been particularly strong in the investment market, and particularly in sustainable or ESG branded ETFs (Exchange Traded Funds). However, there is substantial variation in the metrics and rules used to develop these funds, and many focus on ESG exclusion criteria, rather than on delivering specific sustainability or ESG objectives. Some are simply pre-existing funds that have been re-branded as sustainable.18

Confusion around what ESG products and labels actually mean has driven increased regulatory interest and scrutiny over potential “greenwashing” or misrepresentation of sustainability claims associated with such products. To counter this, regulators have focused on the definition of sustainable finance, alongside the establishment or reinforcement of sustainability disclosure requirements. In EMEA, the EU is at the forefront of this movement with the EU Taxonomy and SFDR.19 The impact of SFDR is already being seen in the market; in February 2022, Morningstar removed the “sustainable” tag from 1300 funds following analysis using the enhanced ESG data disclosed in line with SFDR (Sustainable Finance Disclosure Regulation).20

Beyond this, sustainable finance and greenwashing have featured in regulatory dialogues in the UK, US, Japan, China, France and Netherlands. In October 2021, OECD analysis of several regimes found that:

“there is already a basis for a common language on sustainable finance taxonomies for international issuers and investors that are willing to use such a tool. In individual jurisdictions, well-designed taxonomies can help policy makers to develop and grow sustainable finance markets to support the achievement of environmental and other sustainable development goals.”21

18 World Economic Forum, Why ESG Exchange-Traded Funds might not be as green as you think | World Economic Forum (weforum.org)

19 Principles for Responsible Investment (PRI), Sustainable2 finance policy reform: building momentum in 2022 | Blog post | PRI (unpri.org)

20 ESG Clarity on Morningstar, February 2022 Morningstar drops sustainable tag from 1,200 funds - ESG Clarity

However, even in the EU where the regulation is most advanced, debate remains over which specific activities can be defined as sustainable, with natural gas and nuclear power being key examples.22 This is a critical debate at the heart of the just transition challenge. Countries that are highly dependent on fossil fuels may need to use gas as a tool to displace coal, provide flexibility and ensure stability of energy supply in the short term, whilst still planning for and transitioning towards renewables. The EU taxonomy helps to identify which activities to invest in, but not those that must be phased out, and over what timeline.

The EU Taxonomy has defined transitional activities as being:

“an economic activity for which there is no technologically and economically feasible low-carbon alternative shall qualify as contributing substantially to climate change mitigation where it directly supports the transition to a climate-neutral economy consistent with a pathway to limit the temperature increase to 1.5° C”23

This is broadly consistent with the OECD definition:

“transition finance is intended for economic activities that are emissions-intensive, do not currently have a viable green substitute (technologically, economically or both), but are important for socio-economic development. The essence of transition finance is triggering entity- wide change to reduce exposure to transition risk”24

22 See questions asked at the European Parliament Inclusion of natural gas and nuclear energy in the EU taxonomy (europa.eu); S&P Global, What the inclusion of gas and nuclear in the EU taxonomy could mean for investors and asset managers | S&P Global (spglobal.com)

23 EU Platform on Sustainable Finance, Transition finance report, March 2021, p.

24 OECD, Transition finance: Investigating the state of play : A stocktake of emerging approaches and financial instruments | OECD Environment Working Papers | OECD iLibrary (oecd-ilibrary.org)

With transition finance, two key criterion are i) whether the finance is used to invest in or insure activities that are “green” or ”going greener,” and ii) whether it is required to support social or economic objectives. Transition finance represents the greatest untapped opportunity for finance to drive differential change within the wider economy, whilst supporting a just transition objective. With its key differentiators of a fast and flexible regime, strong track record for innovation, and connection to major global markets, Guernsey is strongly positioned to innovate and develop a market-first, industry-leading product in this space.

Critical to achieving this objective is to ensure that sufficient protections are put in place against the risk of greenwashing. A key hot topic amongst the press, regulators and legal advisors, greenwashing accusations have grown almost as fast as the market they relate to.25 Indeed, Guernsey has already launched a consultation in May 2022 on measures covering both transparency of environmental sustainability related claims and promotion of such products.26 Guernsey has a strong, proactive regulatory regime and is already actively exploring measures to safeguard against potential greenwashing risk.

To protect against potential greenwashing risk, there is a need for a clear, transparent set of rules to govern which activities fall into scope for transition finance. This scope is wider today than it will be in a future world in which key transition technologies are more advanced, and dependency on fossil fuels in developing markets is reduced. These rules must therefore be both sensitive to the varying technical and economic capacities of different industries and geographies today, but also responsive to changes in these conditions over time. Guernsey is already actively exploring opportunities around transition finance. Guernsey is an agile jurisdiction, and well placed to develop a flexible, adaptive model for transition finance and mature this in line with the global environment as it evolves.

25 Bloomberg, Greenwashing Is Increasingly Making ESG Investing Moot: Green Insight - Bloomberg