Green-Banking or Greenwashing? The FCA’s Anti-Greenwashing Rules and the Implications for Firms | Deloitte UK has been saved
Sustainable finance products (SFPs) have been at the forefront of market trends, particularly in the post-pandemic business strategies of financial institutions, and they continue to be the fastest growing segment of the market as of 2023, with annual green bond issuance amounting to $581bn in 2022.
A notable drop in bond markets was apparent in the first quarter of 2022; partly attributed to rising interest rates, global economic uncertainty related to rising inflation and geopolitical conflict. While investments in SFPs also slowed, they have performed relatively well in the bond market.
Other factors that could affect the long-term growth of SFPs include greenwashing, or the practice of making misleading or unsubtantiated sustainability-related claims.
Banks and investment firms with green products will need to consider their greenwashing risks, and how these risks will increase with new regulatory requirements. Moreover, a proactive risk management approach throughout a firm’s business lines will allow it to more easily adapt to a rapidly evolving risk landscape.
Unlike traditional financial products, SFPs are governed by a set of non-financial and voluntary measures (carbon footprint, environmental impact, energy efficiency etc.) and, while the leeway around these measures has enabled the rapid growth of the SFP market, regulators such have expressed concerns around greenwashing.
As regulators work to advance their goals and actions in line with the government’s plan to deliver a net-zero economy by 2050, they have introduced support to improve confidence and encourage growth in the SFP market.
In October, the FCA published the Sustainability Disclosure Requirements (SDR) and Investment Labels Consulation Paper (CP22/20), containing a set of new rules to tackle greenwashing. This follows other publications in recent years in which the FCA has showed that it will toughen its stance on greenwashing.
Although greenwashing is still considered by some in the banking sector to be an emerging risk, these new regulations in addition to changing investor demands will make greenwashing more of a mature risk area that firms will be required to appropriately address.
The FCA’s proposed anti-greenwashing regulations, CP22/20, are designed to target asset managers, however, if enacted these proposed rules would have a significant impact on the risk management requirements for SFP manufacturers and distributers.
Previously, greenwashing has been regulated by standard conduct rules, such as Consumer Duty, and other regulations related to false advertising and poor product standards which weaken consumer confidence in the market. Under the new measures in CP22/20, firms will face additional scrutiny into the green credentials of their products and services, making it necessary to increase vigilance in the following areas:
1. Green credentials and claims: most high-street banks are setting sustainability-related goals, such as net-zero targets, and commitments to align their business practices with the UN Sustainable Development Goals (SDG). However, in cases where the goals are not aligned with the firm’s overall strategy, there is a risk that weak implementation strategies lead to missed targets and expose firms to accusations of greenwashing.
2. Voluntary sustainability disclosures: given the lack of monitoring and the non-standardised nature of climate disclosures such as the Task Force on Climate-Related Financial Disclosures (TCFD), they are easily susceptible to greenwashing.
It is clear from the FCA’s recent messaging, including its Dear CEO letters and SDR proposal, that regulators have laid out the grounds on which it will take action to prevent greenwashing. These actions could have major impacts on a firms’ financial and reputational standing, including through:
With the heightened scrutiny around green products and services, and the higher risks associated with both financial and reputational loss, firms have a material interest in ensuring greenwashing risks are mitigated in their governance frameworks.
Banks which are arranging deals for issuers for sustainability bonds or loans will need to examine their current risk architecture to ensure they are identifying, assessing, and managing the risk of greenwashing.
Many banks and investment firms have not updated their risk and control architectures to manage the risk of greenwashing. Firms need a cross-cutting approach that is suitably dynamic to respond to regulatory changes and to manage the risks associated with green products:
Adapting firms’ risk architecture
Considerations for controls
The practicalities of integrating a new principal risk into a firm’s risk architecture can be considerable task as it impacts risk and control self-assessment, incident management, MI, risk aggregation and reporting, policies and procedures, risk management frameworks, and risk appetite statements. Changes to all these items are likely to have significant internal approval hurdles.
The process of integrating greenwashing risk has similarities to the challenge firms faced when integrating conduct risk into operational risk taxonomies at the outset of the regime.
Having a comprehensive strategy at a firm level can ensure alignment in approach across a firm’s business lines, preventing inconsistent and therefore misleading sustainability claims.
As the source of the funds needed to finance new energy systems, resilient infrastructure, and low-carbon technology, green finance is considered essential in the push towards a net-zero economy. Since 2012, green finance has grown by more than 20 times its market value and as global economies move towards net-zero goals, trends suggest that companies are increasingly reallocating capital away from emissions-intensive businesses to low-emissions businesses.
It is clear from COP27 last year that the next focus for the green transition will not be goal setting, but transparent strategies with clear mechanisms for tracking progress. With COP28 coming up this year, the focus will continue to be on measurable action, including large scale investments into green finance. In this landscape, firms found to be making empty environmental promises or being seen to support such firms financially will face pushback from regulators, consumers, and shareholders.
As governments work to put in place rules to prevent greenwashing, companies have faced greater scrutiny into their green status. For example, the technical realignment under the EU’s Sustainable Finance Disclosure Regulation (SFDR) of Article 9 top rated sustainable funds to the broader Article 8 category resulted in an impact amounting to tens of billions of dollars of client fund value as a result of the downgrade. Similarly, the UK Government will layout its implementation plan for its green taxonomy later this year, which if enacted would create more transparency into funds’ ESG credentials.
Considering the constantly evolving nature of the ESG landscape, firms with a robust green financing risk framework will be able to affect a smooth transition to the new requirements and to take advantage of green financing growth without incurring significant risk of regulatory challenge. Now is the time to review risk management frameworks and take the steps to align with new regulatory requirements and consumer demands.
Mike leads the Banking Regulation team in the London Banking & Capital Markets Group. Having founded the Deloitte regulatory practice in 1992, Mike has a wide ranging knowledge of UK Prudential Regulation Authority and Financial Conduct Authority regulation, as well as increasing knowledge of European Central Bank/European Banking Authority regulation. His remit includes capital and liquidity, governance, conduct, and specific reporting requested by the regulators and clients. He leads the regulatory response on key audit clients and is involved in Brexit work from a governance and processes as well as capital, liquidity and conduct perspectives.
Steve is the Head of ESG Assurance in our Audit and Assurance practice for our UK and North and South Europe partnership. Steve is a chartered accountant and has extensive experience in audit, internal audit and regulatory implementation programs. He has worked with a wide range of companies across all major industries, having developed a thorough technical understanding of products and control practices for non-financial risk management. Steve has significant experience in partnering engagements for the provision of ISAE 3000 / 3410 independent assurance over sustainability information and in relation to the sufficiency of design and operating effectiveness of processes and controls to report on non-financial information.