EU Scrutiny of Greenwashing in Sustainable Finance
- Jul 22
- 6 min read
Updated: Aug 19
At a time where sustainable investments are becoming more and more popular, the phenomenon of greenwashing is naturally also on the rise. Greenwashing is a practice where companies make misleading claims pertaining to their sustainability, making the product appear more sustainable or environmentally friendly than it actually is, ergo ‘greenwashing’. Similarly, there are practices such as ‘purpose-washing’ with companies overhyping their brand’s mission to distract from the actual impact; diversity-washing and health-washing are also on the rise. Here, we discuss the increased occurrence of greenwashing in particular, which has subsequently prompted responses from regulatory authorities and ESMA’s ‘Final Report on Greenwashing’ which establishes a roadmap for monitoring and mitigating such misleading practices across the financial market.
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The Regulatory Evolution of Greenwashing Supervision |
The Green Agenda
Sustainability has moved from being ‘on trend’, to a business imperative and is seemingly growing further in importance over time, shaping financial industries where ethical claims are not only influencing investors but also credit institutions. Accordingly, the European Supervisory Authority (ESA) is committed to scrutinising the Sustainable Investment Value Chain (SIVC) in order to spot the high-risk areas for potential greenwashing; such scrutiny revealed National Competent Authorities often remain resource-constrained in monitoring misleading claims effectively. ESMA subsequently published the Progress Report presenting ESA’s high-level understanding of greenwashing and mapping areas more exposed to greenwashing risks across SIVC.
The Fight Against Greenwashing
Human Resources
ESMA revealed that although National Competent Authorities are progressively adopting a risk-based approach in monitoring misleading claims, they often do not have the resources to monitor such claims effectively; National Competent Authorities are, however, continuously innovating in order to improve such efforts and are even collaborating with environmental experts in order to elevate their supervision capabilities. Steps ESMA encourages National Authorities to take in their oversight include investing in human resources with specific environmental expertise, strengthening access to reliable ESG data, and fostering collaboration with both public and private sustainability experts. Furthermore, ESMA states they will be continuously developing supervisory training programs and a “green finance dashboard”, to keep track of ESG market trends.
In the context of delivering their sustainability-related mandates, National Competent Authorities have expressed challenges regarding hiring personnel with adequate expertise on the subject; this could be due to a lack of access to relevant and high-quality comparable data. Notably, data access issues not only relate to information that is subject to supervision but also to information which may serve as background or reference points for supervisors.
Regulatory Support
In the fight against greenwashing, the European Council and ESMA have also stated that misleading information should be explicitly prohibited under the Benchmark Regulation and benchmarks should take into account ESG factors or pursuing ESG objectives.
The Directive on Markets in Financial Instruments (MiFID II) contains rules on all information published by investment firms and credit institutions providing investment services or conducting investment activities to clients or potential clients; MiFID II provides that communication must be ‘fair, clear and not misleading’ not only in its content but also its presentation. Additionally, the EU has established specific sustainability-related requirements and regulatory frameworks which address the greenwashing issue, such as the Sustainability Reporting Directive (CSRD) and the Sustainable Finance Disclosure Regulation (SFDR), such disclosure regimes and standards are consistent with the EU Taxonomy and further provide a shared, science-based classification system for environmentally sustainable activities.
It is also noted that the MAR prohibits information-based market manipulation, which covers false sustainability-related claims. By supervising and enforcing the application of such regulatory regimes National Competent Authorities aim to mitigate greenwashing risks.
The Cyprus Securities and Exchange Commission (CySEC) like other National Competent Authorities has released various Circulars and Press Releases showing that a greener and more sustainable economy is of the utmost priority for them, (such as Circular C683, among others) and the above regulation has been duly incorporated in their supervision practices and the relevant disclosure obligations for entities under their supervision in order to mitigate the risk of greenwashing. For instance, Circular C704 specifically stipulates that entities must adopt governance structures to mitigate greenwashing risks, especially in high-risk areas such as marketing communications and websites. It is further stipulated that the name of each financial product offered, should not be misleading and must follow ESMA’s guidelines for fund names which was adopted through CySEC Circular C678.
Regulatory Challenges
The current supervisory practices adopted by National Competent Authorities differs in terms of the analysis and methodologies deployed; in response to a swiftly evolving regulatory regime and increased scale and complexity of corporate sustainability disclosures, it is necessary for supervisory practices to evolve at the same rate, which has proved challenging when it comes to maintaining a degree of consistency between National Competent Authorities.
In its Progress Report, ESMA identified various high-risk areas for greenwashing in need of specified attention in the issuers sector. Among those are forward-looking information and pledges about future ESG performance which appeared to be particularly exposed to greenwashing risk. Other high-risk areas include information about contributions to the UN SDGs, information about issuers’ exposure to climate-related risks, sustainability risks, information regarding the governance of sustainability, lack of comprehensive progress monitoring frameworks and effective incentive schemes for senior management. To this end, forward looking information will also increase the complexity of the supervisory work, particularly in the context of preventing and mitigating greenwashing risk; largely due to the fact that such information is based on projections and characterised by a degree of uncertainty about future regulatory, market and technological developments.
The Regulatory Evolution of Greenwashing Supervision
Although National Competent Authorities have not divulged how they perceive their role in terms of supervising sustainability-related requirements, the regulatory regime and legal foundation seem sufficient so that such Authorities may proceed with a high level of ambition for themselves. It is also worth mentioning that non-EU Authorities, such as the Dubai Financial Services Authority (DFSA), US Securities and Exchange Commission (SEC) and the Australian Securities and Investments Commission (ASIC), have likewise already enacted sanctions for greenwashing, highlighting that such practices are taken seriously on a global scale and are far from being a passing trend.
Furthermore, ESMA is in the process of developing an indicator to qualify greenwashing risk in the investment funds industry. Such indicators will be used to assess the quality of specific aspects of sustainability-related claims disclosed by funds. ESMA is exploring different ways of qualifying these risks, such as by evaluating the consistency of sustainability-related claims across fund documents, unsubstantiated use of vague ESG-related language, and connotations and alignment between names/ labels and portfolio compositions.
Additional potential developments in the area that are being explored include efforts to monitor greenwashing and detect occurrences, via the sharing of tools, analysis, methodologies and indicators between National Competent Authorities in order to counteract the challenges presented related to data accessibility, availability, quality and comparability. There is expected progress to be made in the development of machine-readable information, in regulatory documents, and greater accessibility of documents, via the forthcoming European Single Access Point (ESAP), which will give the supervisory community easier access to the raw material necessary for assessments from 2027 onwards.
National Competent Authorities have also mentioned thematic period reports, on-site inspections, dedicated FAQs, specific webinars, and communiques on the implementation of sustainability related provisions in the investment fund industry as well as bilateral engagement with supervised entities.
The use of advanced digital tools for supervision (SupTech tools) can make financial market regulators’ supervisory practices more efficient taking into account the increased scale and complexity of the relevant data. Possible greenwashing supervision techniques also include sentiment analysis, which will evaluate the overall tone of the text used. Such tools will be used to complement human supervision rather than replace it due to their limitations.
With sustainable finance set to expand further in the future, ESMA’s focus seems to be on fostering a transparent market, where sustainability claims align with actual impact. As new policies roll out, it is expected that more transparency and accountability will be demanded and there will be a closer look taken at how companies are living up to their green promises in order to promote a future where sustainable investments are transparent, ethical and economically sound.
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Written by Andie Henderson, Legal and Compliance Associate, FAI Comply
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