Publication Date: 2024-06-04 | Regulator: European Securities and Markets Authority (ESMA)
Summary
The document titled “Final Report on Greenwashing” is a response to the European Commission’s request for input on “greenwashing risks and the supervision of sustainable finance policies.” The report addresses the issue of greenwashing, which refers to the misleading or unsubstantiated claims made by entities regarding the environmental, social, and governance (ESG) characteristics of their financial products or services.
The report highlights that greenwashing can occur at various stages of the business cycle, including manufacturing, delivery, marketing, sales, and monitoring. It can also be triggered by different entities involved in the sustainable finance value chain, such as the entity responsible for the product, the entity providing advice or information, or even third parties like ESG rating and data providers.
The consequences of greenwashing can range from immediate damage to consumers or investors to the gain of an unfair competitive advantage. Regardless of the outcomes, if left unchecked, greenwashing can undermine trust in sustainable finance markets and policies.
The document emphasizes the need to address greenwashing risks and provides insights into the challenges associated with using Natural Language Processing (NLP) tools for greenwashing supervision. It highlights the high number of false positives generated by dictionary-based NLP approaches and the importance of refining expressions to improve accuracy. The document also mentions the challenges posed by ambiguity, lack of standardization in terminology, data limitations, and legal/technical considerations in the use of NLP tools for greenwashing supervision.
While the use of Supervisory Technology (SupTech) tools for greenwashing supervision is still limited, the report indicates that some National Competent Authorities (NCAs) are already utilizing these tools for the supervision of investment managers. The report acknowledges the growing interest in SupTech tools and the efforts of the European Securities and Markets Authority (ESMA) to support NCAs in developing their capacities in this area.
Overall, the document provides insights into the risks and challenges associated with greenwashing and highlights the potential role of NLP and SupTech tools in addressing these issues.
What are the recommendations in relation to NCAs mentioned in the document?
The document provides several recommendations for National Competent Authorities (NCAs) in relation to greenwashing supervision. These recommendations are aimed at enhancing the effectiveness of supervision and promoting supervisory convergence. Here are the key recommendations mentioned in the document:
- Enhancing Human Resources and Capacities: NCAs are encouraged to enhance their human resources and capacities in the area of sustainability-related regulatory and supervisory activities. This can be achieved through capacity-building programs, hiring or contracting sustainable finance experts, and collaborating with relevant national agencies responsible for sustainability matters. The document also suggests considering good practices related to collaboration arrangements and participation in national taskforces.
- Conducting Thematic Reviews and Communicating Priorities: NCAs are advised to conduct thematic reviews to assess compliance with sustainability-related requirements and identify potential instances of greenwashing. They are also encouraged to communicate their priorities and expectations to supervised entities, ensuring transparency and clarity regarding sustainability-related claims and disclosures.
- Developing Risk Indicators, Methodologies, and Tools: NCAs are recommended to develop and deploy risk indicators, methodologies, and tools that can support effective supervision. These tools can assist in the identification of outliers, benchmarking disclosures against external information, and monitoring predefined red flags across corporate information. The document emphasizes the importance of risk-based approaches and the need for common approaches and practices to support supervisory convergence.
- Collaboration and Information Sharing: NCAs are encouraged to collaborate with specialized agencies, such as data- and knowledge-sharing, to enhance their access to data and expertise. Collaboration with other national organizations is also suggested to ensure consistent responses to greenwashing-related complaints. The document highlights the benefits of regular dialogue with market participants and the audit and assurance provision profession in improving the quality of reported information.
- SupTech Tools and Data Access: NCAs are advised to consider further investments in data access and explore the benefits and feasibility of SupTech tools for the supervision of sustainability disclosures. The document acknowledges the resource constraints faced by some NCAs in developing such tools but emphasizes the potential benefits they can offer in enhancing supervision.
These recommendations are intended to support NCAs in their efforts to address greenwashing risks, promote effective supervision, and ensure supervisory convergence across the European Union.
What are the key findings mentioned in the document?
The document highlights several key findings related to greenwashing risks and the supervision of sustainable finance policies. Here are the key findings mentioned in the document:
- Greenwashing Risks: The document acknowledges the existence of greenwashing risks in the sustainable finance market. Greenwashing refers to misleading or unsubstantiated claims made by entities regarding the environmental, social, and governance (ESG) characteristics of their financial products or services. It can occur at various stages of the business cycle and involve different entities in the value chain.
- Challenges in Greenwashing Supervision: The document identifies challenges in the supervision of greenwashing, particularly in the use of Natural Language Processing (NLP) tools. These challenges include the high number of false positives generated by dictionary-based NLP approaches, ambiguity in terminology, lack of standardization, data limitations, and legal/technical considerations.
- Supervisory Efforts: The document highlights the efforts of National Competent Authorities (NCAs) in monitoring greenwashing risks and taking supervisory actions. These efforts include conducting thematic reviews, on-site inspections, targeted reviews of marketing materials, and engaging in bilateral communication with supervised entities. Some NCAs have issued national guidance specifying sustainability-related requirements further.
- Common Supervisory Actions (CSAs): The document mentions the deployment of Common Supervisory Actions (CSAs) by NCAs in the sustainable finance space. CSAs involve concerted supervisory actions on a sample of entities based on common methodologies and expectations. Three CSAs are currently in progress in the investment management, investment service providers, and benchmark administrators’ sectors.
- Greenwashing Occurrences: The document indicates that some NCAs have identified actual occurrences of greenwashing in their markets, while others have identified potential occurrences. These findings have been made through on-site inspections, targeted reviews, information from consumer protection associations and whistle-blowers, and off-site supervision.
- Supervisory Convergence: The document emphasizes the importance of supervisory convergence in addressing greenwashing risks. It highlights the role of Common Supervisory Actions, European Common Enforcement Priorities, and supervisory case discussions in promoting shared understanding, good practices, and effective supervisory methods.
These key findings provide insights into the challenges and efforts related to greenwashing supervision and highlight the need for continued vigilance and collaboration among NCAs to address greenwashing risks effectively.
What are the cross-sectoral considerations relating to the supervisory response to greenwashing?
The document discusses several cross-sectoral considerations relating to the supervisory response to greenwashing. These considerations encompass various aspects of sustainability-related supervision and aim to enhance the effectiveness and consistency of supervisory practices across sectors. Here are the key cross-sectoral considerations mentioned in the document:
- Sustainability as a Priority of Supervision: The document emphasizes that sustainability-related supervision has become a priority for National Competent Authorities (NCAs) and ESMA. It highlights the inclusion of sustainability in ESMA’s strategic priorities and the establishment of transversal internal structures within NCAs to ensure a consistent and holistic approach to sustainability topics.
- Supervisory Mandate and Powers: The document acknowledges the importance of NCAs’ supervisory mandates and powers in addressing greenwashing risks. It suggests that NCAs should consider enhancing their human resources and capacities in the area of sustainability-related regulatory and supervisory activities. It also recommends collaboration with relevant national agencies responsible for sustainability matters.
- Supervisory Approach and Experience: The document emphasizes the need for a risk-based approach to supervision and the importance of supervisory convergence. It highlights the role of thematic reviews, communication of priorities, and the development of risk indicators, methodologies, and tools to support effective supervision. The document also mentions the benefits of collaboration and information sharing among NCAs and specialized agencies.
- Supervisory Capacities and Tools: The document recommends that NCAs consider investing in data access and exploring the benefits and feasibility of SupTech tools for the supervision of sustainability disclosures. It acknowledges the resource constraints faced by some NCAs but emphasizes the potential benefits of such tools in enhancing supervision.
- Pathway to Further Enhance Supervision: The document outlines a pathway to further enhance supervision by providing recommendations to NCAs, ESMA, and the European Commission (EC). These recommendations include enhancing human resources and capacities, conducting thematic reviews, developing risk indicators and methodologies, collaborating with specialized agencies, and exploring the use of SupTech tools. The document also highlights the importance of supervisory convergence and the role of ESMA in coordinating supervisory actions across sectors.
These cross-sectoral considerations provide a comprehensive framework for NCAs and ESMA to strengthen their supervisory response to greenwashing risks and promote consistent and effective supervision across the European Union.
Sector-wise Key Considerations
Insurers
- Sustainability as a priority of supervision: The document emphasizes that sustainability-related supervision has become a priority for the supervisory community. Insurers should recognize the importance of sustainability in their operations and ensure compliance with relevant sustainability-related requirements.
- Supervisory mandate and powers: Insurers should be aware of the supervisory mandate and powers of National Competent Authorities (NCAs) responsible for overseeing their activities. NCAs play a crucial role in identifying, preventing, investigating, enforcing, and remediating greenwashing risks.
- Supervisory approach and experience: Insurers should understand the supervisory approach and experience of NCAs in addressing greenwashing risks. This includes the use of risk-based approaches to supervision, critical scrutiny of documentation, and exercising professional judgment in assessing sustainability-related claims.
- Supervisory capacities and tools: Insurers should consider the supervisory capacities and tools available to NCAs in their jurisdiction. This may include the use of supervisory technology (SupTech) tools, collaboration with other national agencies, and capacity-building initiatives to enhance the effectiveness of supervision.
- Pathway to further enhance supervision: Insurers should be aware of the pathway outlined in the document to further enhance supervision in the coming years. This includes achieving supervisory convergence, deepening expertise in challenging sustainability-related claims, and considering actions recommended for NCAs, ESMA, and the European Commission (EC) to enhance supervision across key sectors.
Investment Managers
- Supervisory mandate and approach: Investment managers are subject to the supervision of National Competent Authorities (NCAs) in accordance with sectoral legislation such as the Alternative Investment Fund Managers Directive (AIFMD) and the Undertakings for the Collective Investment in Transferable Securities Directive (UCITS Directive). NCAs are responsible for overseeing investment managers’ compliance with relevant sustainability-related requirements and addressing greenwashing risks.
- Compliance with sustainability-related requirements: Investment managers are expected to comply with sustainability-related requirements, including those set out in the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation. This includes providing accurate, reliable, and timely sustainability-related information to investors, ensuring transparency in sustainability disclosures, and avoiding misleading or unsubstantiated claims.
- Integration of sustainability risks: Investment managers should integrate sustainability risks into their risk management frameworks and investment processes. This involves considering environmental, social, and governance (ESG) factors in investment decision-making, conducting due diligence on sustainability-related claims, and ensuring the accuracy and reliability of ESG data used in investment analysis.
- Enhanced due diligence and monitoring: Investment managers should conduct enhanced due diligence and ongoing monitoring of sustainability-related claims made by issuers and other market participants. This includes verifying the accuracy and reliability of sustainability-related information provided by issuers, assessing the alignment of investment products with stated sustainability objectives, and monitoring changes in sustainability-related risks and disclosures.
- Collaboration with competent authorities: Investment managers are encouraged to collaborate with competent authorities, such as NCAs, to support the monitoring and supervision of sustainability-related activities. This includes providing information and data requested by competent authorities, participating in industry dialogues and consultations, and sharing best practices and experiences.
These considerations highlight the importance of investment managers’ compliance with sustainability-related requirements, integration of sustainability risks, and collaboration with competent authorities to address greenwashing risks effectively.
Investment Service Providers
- Supervisory mandate and approach: Investment service providers, such as financial advisors and brokers, are subject to the supervision of National Competent Authorities (NCAs) in accordance with sectoral legislation such as the Markets in Financial Instruments Directive II (MiFID II). NCAs are responsible for overseeing investment service providers’ compliance with relevant sustainability-related requirements and addressing greenwashing risks.
- Compliance with sustainability-related requirements: Investment service providers are expected to comply with sustainability-related requirements, including those set out in the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation. This includes providing accurate, reliable, and timely sustainability-related information to clients, ensuring transparency in sustainability disclosures, and avoiding misleading or unsubstantiated claims.
- Suitability and appropriateness assessments: Investment service providers should conduct suitability and appropriateness assessments to ensure that investment recommendations and advice provided to clients are aligned with their sustainability preferences and objectives. This involves considering environmental, social, and governance (ESG) factors in the assessment process and providing clear and accurate information to clients about the sustainability characteristics of recommended investments.
- Due diligence on sustainability-related claims: Investment service providers should conduct due diligence on sustainability-related claims made by issuers and other market participants. This includes verifying the accuracy and reliability of sustainability-related information provided by issuers, assessing the alignment of investment products with stated sustainability objectives, and ensuring the transparency and clarity of sustainability-related disclosures.
- Enhanced disclosure and transparency: Investment service providers should enhance their disclosure and transparency practices regarding sustainability-related information. This includes providing clear and understandable information to clients about the sustainability risks and impacts of investment products, as well as the methodologies and data sources used to assess sustainability characteristics.
- Collaboration with competent authorities: Investment service providers are encouraged to collaborate with competent authorities, such as NCAs, to support the monitoring and supervision of sustainability-related activities. This includes providing information and data requested by competent authorities, participating in industry dialogues and consultations, and sharing best practices and experiences.
These considerations highlight the importance of investment service providers’ compliance with sustainability-related requirements, conducting suitability assessments, due diligence on sustainability claims, and enhancing disclosure and transparency to address greenwashing risks effectively.
Benchmark Administration
- Supervisory mandate and approach: Benchmark administrators are subject to the supervision of National Competent Authorities (NCAs) in accordance with the Benchmarks Regulation (BMR). NCAs are responsible for overseeing benchmark administrators’ compliance with relevant sustainability-related requirements and addressing greenwashing risks.
- Compliance with sustainability-related requirements: Benchmark administrators are required to comply with sustainability-related requirements set out in the BMR, including the disclosure of environmental, social, and governance (ESG) factors and the transparency of methodologies used to calculate benchmarks. This includes providing accurate and reliable sustainability-related information to market participants and avoiding misleading or unsubstantiated claims.
- Transparency of ESG factors and methodologies: Benchmark administrators should ensure transparency in the disclosure of ESG factors considered in benchmark methodologies. This includes providing clear information on the ESG factors taken into account, the data sources used, and the standards and methodologies applied. The disclosure should be published on the administrator’s website and be easily accessible to market participants.
- Prevention of greenwashing occurrences: Benchmark administrators should take measures to prevent greenwashing, such as avoiding misleading benchmark names that suggest ESG characteristics when the benchmarks do not meet the relevant criteria. Administrators should ensure that the disclosed information is consistent with the requirements of the BMR and that any potential greenwashing occurrences are promptly addressed.
- Supervisory actions and practices: Benchmark administrators should engage in regular interactions with NCAs and respond to any requests for information or clarifications regarding sustainability-related disclosures. Administrators should also implement appropriate systems and controls to validate and verify the accuracy and reliability of ESG data used in benchmark calculations.
- Collaboration with competent authorities: Benchmark administrators are encouraged to collaborate with competent authorities, such as NCAs, to support the monitoring and supervision of sustainability-related activities. This includes providing information and data requested by competent authorities, participating in industry dialogues and consultations, and sharing best practices and experiences.
These considerations highlight the importance of benchmark administrators’ compliance with sustainability-related requirements, transparency in ESG disclosures, prevention of greenwashing, and collaboration with competent authorities to address greenwashing risks effectively.
Any additional information firms should pay attention to?
- Substantiating sustainability-related claims: Firms are advised to substantiate their sustainability-related claims and communicate sustainability information in a manner that is fair, clear, and not misleading. This includes ensuring that the information they disseminate, including marketing communications, is accurate and transparent.
- Upgrading governance, processes, skills, and IT systems: Firms are encouraged to invest in building capacities and expertise, as well as IT systems that are capable of managing the new flow of sustainability information. They should implement monitoring processes and report regularly on their progress. It is important for firms to integrate Environmental, Social, and Governance (ESG) risks into their risk management systems and controls. They should also adapt their governance structures and processes to mitigate greenwashing risks.
- Establishing reliable and comprehensive sustainability data: Firms should strive to establish reliable and comprehensive sustainability data. This may involve increasing the recourse to external verification and enhancing transparency regarding ESG data methodologies and the use of estimates.
- Supporting comprehensibility for retail investors: Firms are encouraged to contribute to addressing financial and sustainability literacy gaps among retail investors. This can be done through providing contextual disclosures and exercising caution with the use of aspirational language in advertising.
These points highlight the importance of firms taking proactive measures to ensure compliance with sustainability-related regulations and to mitigate the risks of greenwashing. By substantiating claims, upgrading governance and IT systems, establishing reliable data, and supporting investor comprehension, firms can enhance their sustainability profiles and meet regulatory expectations.
What is the current use of SupTech tools for greenwashing supervision?
The current use of SupTech (Supervisory Technology) tools for greenwashing supervision is still limited but growing. According to the information provided, some National Competent Authorities (NCAs) have already started using SupTech tools for the supervision of investment managers. However, it is important to note that no such tools are currently in use for the supervision of investment service providers, issuers, or benchmark administrators.
The information suggests that the use of SupTech tools for greenwashing supervision is gaining momentum. Several NCAs have reported that they are either already developing or planning to develop SupTech tools for this purpose. Additionally, there are NCAs considering the possibility of resorting to such tools in the future.
It is worth mentioning that the European Securities and Markets Authority (ESMA) has prioritized the development and deployment of SupTech tools in the investment management sector. ESMA is actively assisting NCAs in developing their own capacities and tools in this sector, with the aim of facilitating experience sharing, fostering common approaches, and promoting the use of similar tools.
While the current use of SupTech tools for greenwashing supervision is still limited, the growing interest and planned developments indicate a potential increase in their adoption in the future. These tools have the potential to enhance the efficiency and effectiveness of greenwashing supervision by assisting in the detection of potential misconduct and ensuring compliance with regulatory requirements.
How can natural language processing (NLP) techniques be used for supervision?
Natural Language Processing (NLP) techniques can be used for supervision in several ways. Here are some examples:
- Flagging Misleading Information: NLP techniques can help identify and flag potentially misleading information in large volumes of text-based documents. By using predefined criteria and dictionaries, NLP tools can scan texts for specific terms or expressions associated with environmental, social, and governance (ESG) factors. This can help supervisors detect potential instances of greenwashing or false sustainability claims.
- Quantifying Trends: NLP tools can analyse large datasets of regulatory relevance and quantify trends related to sustainability disclosures. By processing and analysing massive amounts of text, NLP techniques can identify patterns, extract key information, and provide insights into the overall tone and sentiment used in each text. This can help supervisors understand the prevalence and nature of sustainability-related claims and assess their alignment with regulatory requirements.
- Prioritizing Supervisory Actions: NLP techniques can assist in prioritizing supervisory actions by reducing the number of documents that need to be manually reviewed. By automatically scanning and filtering texts based on predefined criteria, NLP tools can help supervisors focus their attention on documents that require further scrutiny. This can save substantial time and resources, allowing supervisors to allocate their efforts more effectively.
It’s important to note that while NLP techniques can enhance the efficiency and effectiveness of supervision, they should not replace professional judgment by supervisory staff. NLP tools can provide valuable insights and assist in the initial screening process, but human intervention and interpretation are still necessary for thorough and accurate supervision.
What are the challenges of using NLP tools for greenwashing supervision?
Using NLP tools for greenwashing supervision comes with certain challenges. Here are some of the key challenges:
- False Positives: NLP tools using dictionary-based approaches may generate a high number of false positives. These tools rely on predefined dictionaries of terms associated with environmental, social, and governance (ESG) factors. However, the use of specific terms or expressions does not always indicate greenwashing or misleading information. Refining the list of expressions and improving the accuracy of the output requires successive rounds of testing and adjustments to minimize false positives.
- Ambiguity and Context: NLP tools face challenges in understanding the context and nuances of language. The same term or expression can have different meanings depending on the context in which it is used. NLP tools may struggle to accurately interpret the intended meaning behind certain statements, leading to potential misclassification or misinterpretation of information.
- Lack of Standardization: The lack of standardized terminology and reporting frameworks in sustainability disclosures poses a challenge for NLP tools. Different companies and organizations may use varying terminology and language to describe their sustainability practices, making it difficult for NLP tools to consistently identify and analyse relevant information. This lack of standardization can impact the accuracy and reliability of NLP-based analyses.
- Data Limitations: NLP tools rely on the availability and accessibility of high-quality data. However, there may be limitations in the availability and quality of sustainability-related data, particularly in terms of transparency and reliability. Incomplete or inconsistent data can affect the effectiveness of NLP tools in detecting greenwashing practices.
- Legal and Technical Considerations: NLP tools may face legal and technical challenges, such as terms of service prohibiting web scraping or anti-web scraping measures implemented by websites. Additionally, the performance and scalability of NLP tools can be affected by the volume and complexity of the text-based information being analysed.
Addressing these challenges requires ongoing refinement and improvement of NLP techniques, as well as the integration of human judgment and expertise in the supervision process. NLP tools should be used as a complement to human supervision, with human intervention and interpretation playing a crucial role in ensuring accurate and reliable results.
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