Sustainable financing and overcoming the risks of ‘greenwashing’

Introduction

The appetite for sustainable financing has gained enormous momentum, driven by international initiatives to tackle climate change and promote sustainable development and the significant flows of international capital towards ESG investments.  

‘Labelled’ sustainable finance products now cover a broad range of instruments from bonds to loans and more recently derivatives, focusing on all aspects of sustainability from financing ‘green’ and ‘social’ projects, to broader sustainability-linked targets covering environmental, social and governance matters. Bonds and loans are regularly oversubscribed, and there are positive reputational upshots for the corporates and their financiers involved in these deals. 

However, with the growing global focus on the credibility of ESG policies and strategies, there is now increasing scrutiny from investors and other stakeholders, and discussions of ‘greenwashing’ are sometimes not far behind.

Risks of greenwashing in sustainable financing

In sustainable finance, actual or perceived ‘greenwashing’ can arise in a variety of ways, including questions around:

• the ‘green’ purpose of the financing and how to maintain this;
• how ESG targets are evaluated and verified;
• how the use of proceeds of the financing is tracked;
• what is reported on, and how it is measured; and
• consequences of breach of the ESG undertakings and reporting obligations.

With companies, including financial institutions, increasingly wanting and needing to address environmental and social change, the risk of greenwashing becomes a real and material issue when companies do not set meaningful, transparent, ambitious and measureable targets. This is equally the case where companies set these targets, but fail to meet them and face no real consequences.

A standardised framework for ESG reporting is an important step

An important step to making meaningful progress in ESG sustainability, and to help safeguard against allegations of greenwashing, or claims of ‘green’ credentials that are without a reasonable basis, will be standardised and mandatory disclosures. The collection, assessment and public reporting of relevant and accurate data by business more broadly, and in sustainable finance transactions specifically, will assist with policy making, but will also increase the pressure on companies to show positive advancement in the metrics being disclosed.

Mandatory disclosures, such as those aligned to the Task Force on Climate-Related Financial Disclosures (TCFD) that will be operate in the UK and New Zealand over the coming years, are designed to significantly improve the availability of carbon footprint and climate-related data in the market. A standardised framework such as this will facilitate greater comparability of green credentials. 

Currently, however, there is no local or global consensus on what activities and investments actually (or should) qualify as “sustainable” or how to assess or measure the sustainability of investments such that climate risk can be accurately assessed and disclosed. Navigating effective ESG disclosure remains a challenging area. 

To meet this challenge on a global level, the IFRS Foundation, whose standard-setting body, the International Accounting Standards Board, sets the globally accepted IFRS Standards for financial accounting, is proposing a new standard-setting body for sustainability. The new International Sustainability Standards Board (ISSB) will aim to deliver a global baseline of sustainability-related disclosure standards that will allow for consistent reporting, assessment and comparison and draw on the work done by a number of voluntary codes such as the GHG Protocol, Global Reporting Initiative and CDP.  

There is still work to do to in order to embed robust and consistent practices across the industry. For now, every organisation (and its financiers) should ensure that in contemplating sustainable financing from a climate change perspective, it at least:

• understands its carbon footprint (based on real data across Scope 1, 2 and 3 emissions under the GHG Protocol);
• sets science-based net-zero (or emissions reduction) targets which are ambitious and meaningful to the organisation’s business to achieve their stated pathway;
• implements, measures and evaluates its goals; and
• is transparent – tracking and reporting (publically, if possible) its goals and its progress and achievements in relation to those goals over the long term.

Driving real, longer-term change

We manage what we measure. Enhancing reporting alone will not achieve the end game and deliver meaningful change. Many countries and companies have announced net-zero pathways to 2050, however we know that the reduction in carbon in these businesses will require a root and branch review to identify where the carbon is created and what change in process or technology will be necessary to abate the emissions.

This raises the further question of the role of sustainable finance in driving longer-term change. There is no clear data on the direct positive impact due to the use of sustainable finance products that wouldn’t have been achieved without them. However, what these products and their uptake in the market have clearly shown is the real commercial imperative that sustainability now represents. With estimated global energy investments to finance net zero by 2050 ranging from US$3.1 trillion to US$5.8 trillion annually until 2050 (up from the current levels of around US$2 trillion annually), there can be no doubt that sustainable finance has a significant role to play in driving the energy transition and sustainable business practices more broadly. 

The current tension lies in sustainable finance’s current role as a ‘transition tool’ and incentive towards more sustainable business models. This is expressed in the Guidance on Sustainability Linked Loan Principles, where sustainability-linked loans are intended to ‘complement and enhance a [company’s] existing sustainability strategy’ rather than form part of the strategy itself. At present, the main consequences for borrowers and issuers (and by implication their financiers) using sustainable finance products are reputational. 

Whilst the threat of reputational damage should not be underestimated, as sustainable finance products mature and evolve, and harmonised reporting standards and more robust and transparent metrics emerge, sophisticated investors will be looking for more. This includes the ability to reliably compare the sustainability credentials of borrowers and issuers, better monitoring of the achievement of ESG targets over the term of the debt, and confidence that they are deploying their capital towards companies and projects which will have the biggest positive impact from a sustainability perspective. This may well trigger an evolution in sustainable finance and require products to include new mechanisms and mandate real consequences for failing to meet the pre-agreed targets. And real targets, with real consequences, will likely be a highly effective way to mitigate allegations of greenwashing.

Where to from here

The wave of change, including ever increasing shareholder activism targeting both corporates and financial institutions, highlights that companies and their financiers need to set meaningful targets, adhere to them and report adequately with respect to sustainability risks, or face potentially serious consequences – reputational and otherwise. The push towards standardised reporting and mandatory disclosures will go a long way towards facilitating this. 

In parallel, the likely evolution in the terms of sustainable finance products will help drive a more robust approach to addressing the commercial and financial risks of business practices that do not credibly meet sustainability expectations. Integrating both climate-related and broader ESG strategies into business strategy, and ensuring the integrity of both financial and sustainability reporting, will signal a real change, and a further step towards mitigating the risk of greenwashing in sustainable financing, and beyond.

Norton Rose Fulbright has been named ‘ESG Legal Advisor of the Year’ at the inaugural IJGlobal ESG Awards