European financial regulators say they are uncovering more cases of greenwashing by asset managers cashing in on booming demand for sustainable finance, and some are starting to turn the screw on funds that cannot back up what they claim.
Trillions of dollars have poured into sustainable investment strategies in recent years and regulators have taken little action to ensure funds are marketed accurately, partly because of the lack of agreement on what ‘sustainable’, ‘green’ and ‘greenwashing’ mean.
That makes it tough for watchdogs to prove deliberate exaggeration of environmental, social and governance (ESG) credentials, but this week IOSCO, which groups watchdogs, published recommendations to help members find firms who may be hoodwinking investors.
Regulatory risks have shot up the agenda since U.S. and German investigators said they were probing claims by the former head of sustainability at Deutsche Bank’s asset management arm, DWS, that it misled investors with its sustainable investing criteria. DWS rejects the allegations.
Lawyers in London said since those investigations were made public, asset managers were rushing to ensure they did not fall foul of regulators.
“We’ve definitely had more enquiries from our asset management client base, particularly around the marketing message – what is green? Are we getting this right?,” said Richard Small, partner at Addleshaw Goddard.
“It’s all too easy for this to turn into a mis-selling issue.”
Regulators in France, Britain, Sweden, the Netherlands and Switzerland said they had found a number of instances where ESG claims were not backed up. The asset managers were asked to provide more information to support those claims, or forced to drop sustainability labels.
That shows how watchdogs are moving beyond the European Union’s landmark Sustainable Finance Disclosure Regulation (SFDR), which in March imposed mandatory ESG disclosure obligations on managers, to take more targeted action.
French watchdog AMF has forced managers to drop ESG labels after finding “completely unacceptable” cases of greenwashing, including funds that justified ESG names by excluding stocks already proscribed under French law, said Philippe Sourlas, head of AMF’s asset management directorate.
“We have a range of tools to tackle greenwashing. It can go from soft bilateral communication with the asset manager, to public guidance issuance, to a sanctions process,” he said.
Nick Miller, asset management department head at Britain’s Financial Conduct Authority, said weak fund disclosures were common.
“Often the quality of the information is not sufficient for us to even begin considering the (fund) application,” he said, adding it also raised questions about whether managers met value for money regulations given ESG funds often charge higher fees.
Switzerland’s regulator FINMA said it is dedicating more resources to tackling the problem and has “immediately eliminated” cases of greenwashing it has found, by forcing managers to drop ESG claims, or amend relevant disclosures.
ESG is one of the hottest investment trends, with assets in sustainable funds nearly doubling in six months to reach a record $3.9 trillion at end-September, according to Morningstar.
That explosive growth has left regulators playing catch up across the globe.
In the U.S., the Securities and Exchange Commission has been asking managers to explain the standards they use for classifying funds as ESG-focused, sources said in September. Earlier this year the SEC said it had found “potentially misleading” claims related to ESG investing.
Britain, France, Switzerland, Sweden, Norway, the Netherlands, Germany and Luxembourg, five of which had identified funds marketed in their jurisdictions which make claims unsupported by the information they disclosed. The other three had not carried out detailed investigations or declined to comment.
Sweden’s Finansinspektionen found around 5% of 400 funds it examined made claims that did not stack up, head of sustainable finance, Johanna Fager Wettergren, said.
“It indicates a broader problem and we can intervene against funds that don’t conduct themselves properly,” she said.
The FCA’s Nick Miller said poor ESG disclosures were so widespread in the UK that it had written to fund manager boards in July setting out their need to disclose sustainability approaches in prospectuses and show how strategies can meet ESG objectives — like why they choose certain stocks over others.
The United Nations-backed Principles for Responsible Investment (PRI), an investor network, said it welcomed regulatory efforts to tackle the problem of greenwashing.
But CEO Fiona Reynolds said supervision should be proportionate and “investors must not be discouraged from creating sustainability-focused products due to burdensome requirements.”
The approach of regulators to date has centred on publishing guidance and engaging in dialogue with managers.
Proving deliberate mis-selling is hard when definitions of ‘sustainable’ or ‘green’ are still being debated. Some doubt the success of prosecuting cases under the current regulatory framework.
In the UK, the FCA’s Miller noted that poor fund disclosure doesn’t mean anyone had necessarily broken any rules.
The Dutch, Norwegian, Swedish and Swiss regulators said they hadn’t launched any greenwashing-related enforcement action yet.
Switzerland’s FINMA said statutory definitions of terms such as ‘sustainable’ and ‘environmentally friendly’ were needed first, while French regulator AMF is looking for improvements in ESG data and better definitions to help combat greenwashing.
The Dutch watchdog is waiting for the July 2022 introduction of SFDR’s second phase, a more detailed application of the new disclosure rules, before it takes any action against managers individually, said AFM’s senior supervisor Zoë du Chattel.
Tamara Cizeika, counsel at Allen & Overy, said that although regulators do understand new rules have a teething period, they are signalling that they are ready to take a tougher line.
Britain’s guiding principles, for example, are about the application of existing laws to a slightly new context, making it harder “for asset managers to say ‘can I have time to get it right?’,” she said.
“This is all about investor protection and market integrity. We’d argue that boards should sit up and take notice because it is a significant and growing risk.”