ESMA publishes final report on greenwashing

On 4 June 2024, the European Securities Markets Authority (ESMA) published its final report on Greenwashing in the financial sector (Final Report). The Final Report responds to the European Commission’s May 2022 request to the three European Supervisory Authorities (ESAs) (the EBA, EIOPA and ESMA) for their respective input on greenwashing risks and supervision of sustainable finance policies.

The supervision of sustainability-related claims has become a priority for national competent authorities (NCAs). NCAs and ESMA are taking steps to monitor and detect greenwashing and to critically scrutinise sustainability-related claims. The ESA’s final reports investigate the current supervisory response to mitigating greenwashing risks in their sectors and provide a forward-looking view of how supervision could be gradually enhanced.

In this update we focus only on the key findings and recommendations of ESMA’s Final Report, relevant to fund managers as market participants involved in the sustainable investment value chain (SIVC). The Final Report also contains considerations specific to financial advisers, credit rating agencies, benchmarks administrators, and issuers of securities, who should consult the relevant sections of the report.

ESMA’s Final Report on greenwashing is a valuable source of information for fund managers, as it provides insights into the supervisory approach and expectations regarding sustainability-related claims and disclosures.

Scope of greenwashing

ESMA’s Final Report builds on and validates the findings of its progress report published in June 2023, which provides a shared reference point for market participants and supervisors in dealing with greenwashing. ESMA confirms the ESA’s common-high level understanding of greenwashing, set out in their progress reports as:

a practice whereby sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services. This practice may be misleading to consumers, investors, or other market participants.

ESMA reiterates that financial market players have a responsibility to provide sustainability information that is fair, clear, and not misleading.

ESMA also confirms the core characteristics of greenwashing that it and the other ESAs had identified in their respective progress reports. These include that sustainability-related misleading claims can occur and spread either intentionally or unintentionally and that, in their view, greenwashing does not require investors being actually harmed. They also agree that greenwashing can occur in relation to entities and products that are either under or outside the remit of the EU regulatory framework and can be triggered by third parties (e.g. ESG rating and data providers, or third-party verifiers).

In support of a risk-based approach to supervision, ESMA also confirms its progress report identification of the areas more exposed to greenwashing risks, and preliminary remediation actions. These are set out in Annex I of the Final Report.

ESMA’s key supervisory findings

• NCA’s already prioritise the supervision of sustainability-related claims, performing critical scrutiny of documentation and exercising professional judgment.
• Greenwashing can be captured by existing EU rules prohibiting misleading information or on infringements against specific sustainability-related requirements.
• Limited number of actual or potential occurrences of greenwashing detected, which may reflect various factors such as low levels of complaints reaching NCAs or limited resources and expertise for detection. It may also reflect early successes by NCA’s in preventing greenwashing.
• Formal enforcement decisions related to greenwashing are limited. NCAs have addressed most irregularities in ongoing supervision and favour a gradual approach in the implementation of the new regulatory framework. Unclear or ambiguous definitions may also contribute to difficulties in detecting infringements.
• NCAs and ESMA have started building sustainability-related capacities and expertise through training programs, recruitments, and cooperation with relevant agencies or NGOs.
• Effective supervision builds on NCAs' access to relevant, high-quality, and comparable data, which is identified as a challenge by almost all NCAs, with data referring either to (1) the information that is the subject of the supervision or (2) to information that can serve supervisors work.
• Supervisory Technology (SupTech) tools may increase supervisory efficiency, with only a few NCAs currently using such tools, but the majority are developing or planning to do so.

Priority actions for supervisors

• NCAs are expected to gradually deepen their critical scrutiny of sustainability-related claims. To achieve this, they are invited to continue increasing human resources and expertise, making investments in supervisory tools such as SupTech solutions and further embed greenwashing risks in their respective supervisory work programmes.
• ESMA will continue to support the monitoring of greenwashing risks, the deployment of SupTech tools, and capacity building.  In addition, ESMA will prompt Common Supervisory Actions (CSAs) where needed. ESMA may produce additional guidance for market participants and supervisors in high-risk areas of greenwashing.
• The European Commission is invited to reinforce NCAs’ and ESMA’s mandates in certain areas, such as for benchmarks, and make sure all NCAs have the powers to promote retail investors’ financial education. Whenever possible, the Commission should ensure the legislative framework supports NCAs’ access to data.

A complete list of actions for consideration by NCAs, ESMA, and the Commission is set out in Annex 1 of the Final Report.

The goal of the ongoing CSA is to assess the compliance of supervised entities with relevant provisions of the SFDR, the Taxonomy Regulation and the UCITS Directive and AIFMD. The Central Bank of Ireland (CBI) began its CSA engagement by issuing a questionnaire to Irish fund managers in August 2023 and subsequently conducting site visits. ESMA’s complete assessment can be expected towards the end of 2024. In the meantime, ESMA notes that NCA feedback on a first set of questions have been reviewed to gather information on greenwashing risks and the findings have informed the Final Report.

Beyond the CSA, NCAs have carried out various supervisory actions aimed at the prevention of greenwashing, such as engagement with industry to communicate supervisory expectations on new legal requirements and thematic reviews. NCA feedback to ESMA includes the importance of ex-ante reviews as an important safeguard from potential greenwashing. ESMA notes good practices such as greenwashing screening tools and at the same time acknowledges the supervisory challenges faced by NCAs.

Practical Implications for fund managers

It is important for fund managers to understand where greenwashing risks may arise, and also to address these risks in the context of the evolving sustainable finance legal framework.

In Annex I of the Final Report, ESMA provides a list of remediation actions that should be considered by market participants. These include that they:

• substantiate sustainability-related claims and communicate sustainability information in a manner that is fair, clear, and not misleading
• build capacities and expertise, IT systems fit for managing the new flow of sustainability information
• implement monitoring processes and report regularly on progress
• integrate ESG risks into risk management systems and controls
• adapt governance structures and processes to mitigate greenwashing risks
• fulfil due diligence responsibilities on ESG data
• where relevant, increase recourse to external verification
• enhance transparency on ESG data methodologies, the use of estimates
• address financial and sustainability literacy gaps among retail investors and exercise caution with aspirational language in advertising

It also includes that fund managers should continue to have regard to the high-risk areas identified in the Progress Report, as these will continue to be NCAs supervisory priority.

High risk areas include misrepresentation (e.g., exaggeration, ambiguity, omission, lack of meaningful assumptions) of claims relating to:

• fund level claims on sustainability characteristics or objectives (including climate change mitigation objectives)
• impact  
• engagement with investee companies
• entity-level net-zero targets and transition plans disclosures
• sustainability-based remuneration systems
• a fund or fund manager’s ESG strategy and ESG credentials (such as ESG labels, ESG ratings or ESG certifications)
• fund names
• ESG governance

They are most likely to arise in fund prospectuses, marketing materials (factsheets, sustainability and impact reports, engagement reports) and labels.

Annex 2 of the Final Report helpfully maps the main legal provisions that may be relevant when dealing with instances of greenwashing.

Next steps

ESMA will continue to monitor greenwashing risk and supervisory progress, including through its ongoing Union Strategic Supervisory Priority (USSP) on “ESG Disclosures.” It will also publish an Opinion, building on the preliminary regulatory remediation actions identified in its progress report with views on how the EU regulatory framework for sustainable finance could further facilitate the investors’ journey. ESMA’s Opinion will also build on the recently published Opinion of the Joint Committee of the ESAs on the assessment of the SFDR.

For more information on ESMA’s Final Report on greenwashing or on other sustainable finance developments in the asset management sector, please contact any member of A&L Goodbody’s Asset Management and Investment Funds team.

Date published: 21 June 2024