Greenwashing in the banking sector

The concept of greenwashing, has gathered significant attention from legislators, regulators and the public lately. In the tidal waves of the sustainability legislation coming from EU in recent years, it has yet become increasingly important from a legal perspective. 

The European Banking Authority's (EBA) recently published progress report offers insights into the topic. [1] The report shows a clear increase in the total number of potential cases of greenwashing across all sectors, including EU banks, since 2012. It further highlights the significance of mutual comprehension among the stakeholders to avoid contribution to greenwashing and more importantly, to uphold the ongoing endeavors towards a sustainable economy and the mitigation of global warming. 

Failure to do so would not only jeopardize the integrity of environmental initiatives in the financial sector but also undermine the pursuit of legal remedies and the attainment of a harmonized regulatory framework to address these pressing concerns.

Climate change and the necessity to adopt to a more sustainable economy has become one of the most pressing issues globally and is currently one of the top priorities within in EU's political agenda going forward. The demand and supply for sustainable products has been skyrocketing in recent years where banks together with other financial institutions have become one of the flag bearers for providing financing to the green transition. 

One of the side effects of this change is the concept of greenwashing which, despite having been around for over 20 years, recently has attracted increasing attention. This extended focus has the potential to negatively impact the sustainable economy by reducing investor confidence in crucial investments.

A bank can potentially engage in greenwashing in multiple ways, both at entity level and product level. EBA's progress outlines the adverse impact greenwashing can have on the financial risks of institutions and, ultimately, on consumers. 

The Report provides an overlook at the current situation in the European member states, with the purpose of presenting a common understanding of the key features, such as different types of greenwashing, its characteristics, market trends and the financial risks associated with greenwashing.

There is no legal definition covering the exact scope of what could potentially be regarded as greenwashing. The common understanding in the Report however, is that it may be defined 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’.

At first glance of the definition, it is clear that there are many actions and roles in the banking industry that may be in scope of the definition. It is important for everyone involved to have a deeper understanding of these roles and actions in order to identify and manage potential risks. That way, market participants and stakeholders can avoid becoming victims or unknowingly contribute to greenwashing.

The Report suggests that market participants and stakeholders can be divided into different roles depending on each participant's incentive and/or position in the value chain of the market. A market participant may act as a 'trigger' when it initiates a greenwashing action, e.g., when offering a financial product to a customer labeled as "green" or "sustainable" without basis for that claim. 

A market participant can become a 'spreader' if it enables or communicates greenwashing to other market participants or stakeholders. Such situations could occur when an ESG-rating institute provides false or misleading data to the market or when an investment advisor (intentionally or by negligence) provides incorrect advice in connection with a loan or financial product.^[2]

A market participant is considered a 'receiver' of greenwashing in any situation leading to a purchase of a financial product or a financial service, which have been falsely marketed as green or sustainable but is not.

The Report includes several real market examples that may be observed at both the entity level and on the product- or service level, which is further outlined below. 

Examples on entity level
On entity level, i.e., corporate banks, retail banks, credit institutions, payment services providers and investment firms, the most common type of greenwashing, pertains to the companies' business strategies. Amongst the reported examples were: 

• Misleading the stakeholders into believing a financial institution is contributing to the fight against deforestation, while at the same time investing in a corporation allegedly linked to deforestation in the Amazon.
• Selectively promoting the financial institution’s commitment to be part of the climate solution, while at the same time providing financing to oil companies operating in the Arctic.
  
• Presenting the institution's business model as sustainable in Europe, while, at the same time, financing environmentally unfriendly agricultural business in third world countries.
  
• Making claims regarding its efforts to mitigate climate change and at the same time omitting information regarding its own contribution to greenhouse gas emissions.

A common factor in the examples above is the strategy of highlighting sustainable initiatives, in parallel with omitting information of the market participants' non sustainable activities or its negative impacts. 

When it comes to business strategies regarding commitments on the public market, particularly in relation to decarbonization, a common trend can be observed. Market participants often pledge to make changes and adjust their investment and lending operations to become more sustainable, but struggle to provide the public with a credible transition plan supporting these pledges.

The examples (while publicly committing to contribute to decarbonization) in the Report include inter alia: 

• Lobbying against climate policies in Europe, in the UK, and the US and thereby undermining their own net-zero carbon commitments.
• Large investments in oil corporations (where such investments did not finance the oil companies' sustainability transition) despite the market participant being a member of the Net Zero Banking Alliance.^[3]
  
• Publicly claiming to be working to reduce global carbon emissions, while at the same time, continues to offer loans to corporations building coal-fired power plants.

Examples on product and service level
As far as banks' alleged greenwashing on product and service level, a few reported examples were: 

• Portraying a financing of an airport project as environmentally friendly, despite significant negative impact on biodiversity and increase of greenhouse gas emissions.
• Extending sustainability-linked financing to a corporation in charge of constructing oil sands pipeline, despite criticism from indigenous people due to alleged impacts on their lands and waters.
  
• Misguiding customers about the impact on the personal carbon footprint of a financial investment, in relation to the bank's products and services.

Market participants are currently confronted with the challenge of facing adverse impacts caused by greenwashing events. These events can potentially have harmful effects on an entity's financial situation, thus exposing them to various financial risks. The Report identifies various risks, including reputational, operational, strategic, business, liquidity and funding, credit, and market risks. 

Among these, reputational and operational risks are considered particularly significant by both the stakeholders and competent authorities.

Reputational risk
Reputational risk represents one of the most prominent hazards associated with greenwashing, given the growing attention towards environmental concerns that stakeholders must increasingly contend with.

A bank or a financial institution can face a risk to its reputation as a result of consumer associations' initiatives that contribute to a degradation in the public eye or reputation of an institution when it is discovered or perceived to be engaged in greenwashing. Reputational risks may also arise from published customers complaints or media information revealing that an entity is engaged in financing activities harmful to the environment or to social factors. 

Reputational risk could be deemed the core financial risk caused by greenwashing, as it very well may result in the increasing of other financial risks. For instance, if a company's reputation is at risk, it can also result in difficulties in retaining customers, difficulties in attracting customers to new sustainable product offerings, loss of key employees, business partners or investors. 

Operational risks, litigation, and liability
With regards to operational risk, (such as potential losses or harm arising from insufficient or failed internal processes), stakeholders are encountering growing challenges in aligning themselves with environmental and social principles. These challenges pertain to both internally established code of conduct guidelines and stakeholder's claims of sustainability alignment communicated to the market and its customers. 

Operational risks can take the form of liability claims towards a company arising from a mis-selling of products marketed as green or sustainable. It could also arise from litigation cases against institutions due to misalignment between their internal ESG-policies and some of the institution's activities. 

Materialized operational risks encompass a variety of adverse impacts, including financial losses in terms of fines or penalties imposed through judicial or regulatory proceedings, compensation to third parties as mandated by courts or regulators, withdrawal or reclassification of financial products, temporary prohibition to operate and/or to issue the product on the market, as well as associated legal fees.

Secure internal governance
In summary, the Report shows the importance for all stakeholders, regardless of where in the finance value chain they are located, to gather internal knowledge of how their own products, internal conduct rules and business strategies could be impacted by greenwashing. Failure to do so could result in risks for the individual bank/entity, in particular reputation and litigation risks but also business risks and financial losses. 

Evaluate green credentials of product offerings
Many financial institutions are currently adapting their business strategies to better align with a more sustainable economy which hardens the competition for customers within sustainable finance. As the market share of green financial instruments increases, and their price is to a higher degree is dependent on their green credentials, it is important for each entity to secure that provided financial services and products reflect the underlying sustainability profile. 

Evaluate legal risks
Legal risks may arise as a result of breaches in consumer protection laws or with contract parties concerning sustainability claims or environmental benefits. Legal risks may also occur due to non-compliance with sustainability frameworks, violations of laws or regulations related to marketing or advertising, or investor lawsuits due to the misallocation of loans or financing for non-sustainable projects. 

Schjødt's services
Schjødt's integrated banking and finance team provides market leading expertise and combines the full range of banking and finance services across all of Scandinavia. In addition, Schjødt's dedicated team for financial services consists of lawyers at the forefront of this environment and provides top-tier legal advice to the industry. In relation to avoiding greenwashing and other related sustainable finance matters, Schjødt offer inter alia legal services in connection with the following: 

• Issuing of various loan products
• Issuing green bonds
• Sustainability linked financing activities
• Categorizing financial products as green or sustainable
• Review of sustainability claims and business strategies
• Review and establishment of internal frameworks or ESG-policies.
• Review of marketing material in relation to consumer protection regulation.

The Progress Report is a result of the EU Commission's objective to accomplish a common high-level understanding on greenwashing within all ESAs, and it should be noted that both the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) have published similar progress reports which may be found using the links below. See also further information about the Net Zero Banking Alliance.

Read the ESMA Progress Report on Greenwashing here.
Read the EIOPA Progress Report on Greenwashing here.
Read about Net Zero Banking Alliance here.

<sup>[1] https://www.eba.europa.eu/esas-present-common-understanding-greenwashing-and-warn-related-risks

[2] The European Commission have proposed a new Regulation on the transparency and integrity of ESG rating activities, on which Schjødt have already published information of in a previous article.

[3] Net Zero Banking Alliance brings together a global group of banks, currently representing over 40% of global banking assets, which are committed to aligning their lending and investment portfolios with net-zero emissions by 2050.</sup>