ESMA Told to Watch and Wait on ‘Greenbleaching’

Advisory group outlines its recommendations on addressing SFDR Article 9 downgrades and greenwashing regulatory uncertainty. 

The European Securities and Markets Authority’s (ESMA) advisory group has warned against sanctioning ‘greenbleaching’, with industry experts calling for ESMA to provide more “legal certainty” around existing sustainable finance regulation and terminology to reduce greenwashing risk.

The Securities and Markets Stakeholder Group (SMSG) published its paper earlier this month, following ESMA’s request to advise on a “holistic” definition of greenwashing, whether or not greenbleaching is a problem from a supervisory perspective, how ESMA can deal with Article 9 downgrades, and whether intent should be a consideration when identifying instances of greenwashing.

The SMSG defined greenbleaching as the phenomenon of fund managers investing in sustainable activities but refraining from claiming them as sustainable to avoid the legal risks surrounding greenwashing.

“Greenbleaching and greenwashing are both different sides of the same coin,” said Andreas Stepnitzka, Deputy Director of Regulatory Policy at the European Fund and Asset Management Association (EFAMA).

ESMA’s greenbleaching concerns centre around a number of asset managers downgrading their Article 9 (environmental and/or social objective) funds to Article 8 (environmental and/or social characteristic) ahead of Level 2 of the Sustainable Finance Disclosure Regulation (SFDR), which went live in January.

These downgrades were prompted by “regulatory uncertainty” around Level 2, said Frédéric Vonner, Advisory Partner at PwC Luxembourg. Level 2 requires asset managers to provide detailed disclosures to justify the selected label of their sustainability-focused funds, but many are confused about the terminology used, he said.

“This volatility [the downgrades] definitely has the potential to undermine investor confidence in sustainable finance and threaten efforts to transition to a more sustainable economy,” Stepnitzka told ESG Investor.

However, the SMSG paper warned against ESMA sanctioning asset managers that have chosen to understate the sustainability credentials of their products by downgrading from Article 9 to 8. While this can be considered misleading, the advisory group noted there is no legal obligation to disclose how sustainable a product is and so greenbleaching therefore cannot be considered a “misrepresentation”.

The SMSG has advised ESMA to instead monitor ongoing downgrades, “in order to assess whether (or not) sustainable finance legislation reaches its goals”.

Thresholds put the squeeze on Article 9  

A key point of contention with SFDR is that the definition of an Article 9 product is “too narrowly interpreted by the regulator [ESMA]”, said Martin Mager, Investment Funds Partners in Luxembourg at law firm Linklaters.

The narrow definition of ‘sustainable investments’ is “pushing investment managers that clearly have sustainability in their DNA into classifying under Article 8 instead of Article 9”, he said.

“If the goal is to define Article 9 funds fairly strictly to ensure the highest sustainability criteria, then it makes sense that the number of these funds in declining,” noted EFAMA’s Stepnitzka.

“Investment funds are always a reflection of the economy itself, and unfortunately there is still an enormous lack of sustainability ambition, and data showing this, coming from your average corporate.”

However, Stepnitzka added that this is starting to change through the implementation of the Corporate Sustainability Reporting Directive (CSRD).

The SMSG also noted the ongoing lack of clarity on what constitutes a ‘sustainable investment’ under SFDR and how this is driving funds away from an Article 9 qualification, ultimately contributing to greenbleaching.

“The risk arises that the Article 8 category becomes meaningless, while the Article 9 category becomes empty,” the group said.

The SMSG said the regulator has an important role to play through its monitoring of greenbleaching the market, identifying its causes and “flagging [these] to the Commission”.

In the meantime, PwC’s Vonner said it is likely there will be more Article 8 than 9 funds in the near future, although the market may see a growth in “specialised Article 9 funds” which target very specific sustainable themes.

Mager added: “To mitigate these issues it would, for the time being, be helpful to have more legal certainty on many of the open questions that still exist with respect to existing regulation, correct certain interpretations that may, in an attempt of the regulator to combat greenwashing, be too restrictive, and also to provide rules with respect to the lack of data or data quality, particularly in the first years following the application of a new regulation.”

The SMSG was set up to advise ESMA on its policy work, with members spanning industry bodies, academia, investment firms and consumer groups.

A matter of intent 

Alongside greenbleaching, the SMSG was also asked by ESMA to provide a definition of greenwashing and consider whether intent should be factored into greenwashing assessments.

“The term ‘greenwashing’ is not used consistently,” said Mager from Linklaters.

“There are some obvious cases where products are sold in a misleading way,” he said. “At the same time, there are many situations where fund managers naturally have problems classifying their products appropriately and where it may be inappropriate to mark this as greenwashing.”

The SMSG defines greenwashing as: “The practice of misleading investors, notably (but not limited to) in the context of gaining an unfair competitive advantage, by making an unsubstantiated ESG claim about a financial product or service.”

The group said its holistic definition has taken account of three principles: aligning with and connecting to existing definitions of greenwashing and misleading information in European legislation, ascertaining such a definition for the financial sector is in line with definitions applied in other economic sectors, and making sure the definition in the financial sector refers to existing anti-greenwashing legislation.

For the latter, the paper said that only if existing anti-greenwashing is “not considered sufficient could new rules or sanctions be introduced”.

The paper further noted the importance of attributing responsibility for identified greenwashing at the correct level of the value chain.

“But the tools to manage greenwashing are already there, and it is up to national supervisors to address [any greenwashing issues] when they authorise the documentation of funds,” countered Victor van Hoorn, Managing Director of the Investment Company Institute (ICI), an association representing regulated investment funds.

Failing to meet the investment objective of the fund doesn’t necessarily mean that greenwashing has taken place, the SMSG paper noted, arguing that “investment objectives are obligation of means, not of result”.

“There can be a slight mismatch between what some investors think they might be buying when investing in an Article 8 or 9 product, versus what the product actually does based on its disclosures,” van Hoorn told ESG Investor.

“That’s not necessarily a question of misleading or wrong disclosures, but of investor education and expectations.”

The paper said that it is important that investor expectations are “well managed”, with ESMA and other national competent authorities having an important role to play in investor education and awareness.

“The SMSG has provided a lot of food for thought,” said Mager.

“ESMA should use this as an opportunity to provide more legal certainty on existing regulation and also correct certain excessive interpretations in order to give SFDR’s Article 9 a broader scope of application.”

Read more articles like this on Regulation Asia’s sister publication, ESG Investor.

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