With strong growth in recent years, sustainable investment products are also becoming increasingly regulated, in order to help investors make the right choices and ensure that their investments have a real impact on the environment, social issues and good governance (ESG). In this context, it is also important to ensure that the promises made by fund promoters match the reality on the ground. In other words, that they are not engaging in greenwashing. “The issue of greenwashing is a direct response to the growth in sustainable investment and the financial sector's focus on ESG issues,” says Julie Pelcé, senior associate and ESG specialist at CMS Luxembourg.

Greenwashing is the practice of presenting a consumer product or--in this case--a financial product, as being more sustainable than it really is. “The first consequence of greenwashing is obviously the deception it involves, which is to the detriment of the consumer. But it is also an anti-competitive and unfair practice that goes so far as to affect other companies in the financial sector, those that are making a real effort to contribute to sustainability,” argues Pelcé.

More generally, greenwashing reduces consumer and investor confidence. These deceptive practices must therefore be avoided at all costs. “The financial sector has a real role to play in the environmental and social transition that is underway today. It can have a real impact if it demonstrates the utmost transparency, which is a guarantee of its reliability”, says Pelcé.

Proven deceptive practices

Greenwashing practices are currently rife in the investment fund industry. “According to an article by the European Securities and Markets Authority (Esma) published at the end of last year, the financial sector is the second sector in which there are the most allegations of greenwashing, just after the fossil fuel sector (oil and gas),” Pelcé points out. At a time when European players are in the midst of considering the overhaul of the SFDR regulations, and many are calling for a clarification of the standards linked to sustainable finance, recent reports from the European Financial Services Authority have highlighted the financial sector’s lack of transparency when it comes to sustainability.

“According to the Esma’s research, funds that claim to be committed to the Sustainable Development Goals (SDGs) and suggest that they are contributing to the achievement of these goals are not actually performing any better than other funds in terms of impact,” explains Novethic, an organisation that works to advance sustainable practices in finance and business. Esma has analysed the composition of the portfolios of nearly 200 “SDG funds” operating in Europe, i.e., funds claiming to contribute to the Sustainable Development Goals. This analysis reveals that the composition and management of these funds are similar to those of other investment funds, and that the marketing of the funds around the SDGs is misleading.

Regulated fund names

On 14 May, Esma published its final report on the criteria to be respected by financial players when using sustainability-related terms in the names of their funds. The institution has established a set of guidelines aimed at defining the circumstances in which fund names using ESG or sustainable development terms are unfair, unclear or misleading. Investment fund managers will have to comply. “This new regulation is welcome. In the future, it should ensure that portfolios are consistent with the terms used in their names. Another point worth highlighting is that this text takes into account the case of transition funds, taking care not to introduce overly restrictive rules that could slow down the growth of this type of fund, which has an important role to play in the transition process,” explains Pelcé.

At a time when the market for so-called sustainable funds is growing steadily, this is a reminder of the importance of establishing a clearer regulatory framework, making it easier to find one’s way through the jungle of terminology in the sector. “There is currently no legal framework for sanctioning greenwashing as such on the financial markets,” says Pelcé. “However, regulators, in their role of protecting consumers and investors, can intervene to combat greenwashing. The applicable regulations on the prohibition of misleading information and a number of other texts on the obligation of transparency around the sustainability criteria of financial products are there to help them do so.”

Prevention rather than cure

To avoid abuses, we must first and foremost work on preventing the risks associated with greenwashing. “All market players should tackle this problem head on. In particular, it is up to the public authorities to define stricter standards, to issue instructions and best practices to be implemented. It is also up to consumer associations to raise awareness and denounce any misleading practices of which they become aware,” says Pelcé. “Finally, for asset management companies, it is essential to ensure that they have the right tools in place to monitor compliance with all the new sustainability requirements, in a transparent and proportionate way.”

As well as putting these tools in place, the companies concerned also need to establish strong governance over these ESG issues, to turn them into real assets. “In our discussions with our customers, we place a great deal of emphasis on the importance of training all our teams, in view of all the requirements that apply to market players in taking account of these new sustainability risks. Internally, we need to ensure that all processes are adapted to this new dimension, and meet the expectations of the market and regulators, in particular by establishing robust governance. We also need to ensure that all those involved in the company are aware of the challenges of sustainability, right up to the board of directors. Finally, it is recommended that a member of management should specialise in these matters or, failing that, that a dedicated committee should be set up to specifically address sustainable investment issues.”

Proportionate communication

To avoid greenwashing, the important thing to remember is that communication must be proportionate. “You have to say what you do and do what you say,” Pelcé sums up. It’s also important to avoid cherry-picking, which means presenting facts or data that give a good image of a product while overlooking anything that could tarnish it. Another good practice is to boost investor confidence by having funds labelled by independent bodies.

One of the main challenges when it comes to integrating sustainability into financial products is the availability and relevance of data. “Regulations, which are becoming increasingly comprehensive, are there to help players to have the right information at their disposal. All levels of the value chain are beginning to be regulated and must demonstrate greater transparency, which should facilitate access to reliable data. However, we have to accept that this transition to a greener market will take time,” adds Pelcé.

When it was first introduced, the SFDR was seen by some as a marketing tool. Then, after a period of adjustment, with the support of the regulators who published their guidelines and drew attention to the practices to be avoided, the market better understood what was expected of it. It has adapted. Funds have been declassified, notably in January 2023, because they did not meet sustainability requirements. But the market has regulated itself, aware that there is no point in taking risks.

This article was written for the ESG supplement to the July 2024 edition of Paperjam published on 19 June. The content is produced exclusively for the magazine. It is published on the website to contribute to the complete Paperjam archive. Click here to subscribe to the magazine.

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This article was originally published in French.