With the rapid growth of sustainable products and investments, the pressure for genuine corporate sustainability has intensified. Increasing investor scrutiny and accelerating climate breakdown and biodiversity loss, for example, play a part in this. In-House Perspective explores whether increased awareness owes as much, however, to reactions to the rising tide of ‘greenwash’ – when corporations make misleading claims about their green credentials.

As sustainable investment turns from trickle to flood, a whole new, increasingly automated industry has grown up to tackle the proliferation of all-too-often poor quality corporate data and verification of claims, with mixed results. It’s yet to fully close the credibility gap. Meanwhile, corporate lawyers find themselves at the heart of the ‘greenwash’ and wider sustainability debate, either at the sharp end – defending product and service claims from legal challenge – or more proactively trying to clear up confusion and minimise the corporate environmental, social and governance (ESG) impact of supply chains.

Greenwash – bad apples or category mistakes?

So what is greenwash? The term was first coined in 1986 by environmentalist Jay Westerveld to cover misleading information aimed at conveying the impression that a company’s products are manufactured in environmentally conscious ways, often with the intention of free-riding on growing demand for environmentally friendly products and action. The term also covers exaggerated or unsubstantiated claims, and where materially important information is hidden, but many more corporates are at risk of falling foul due to lack of care, expertise or capacity to monitor adequately.

Surveys of advertising by the UK’s Competition and Markets Authority suggest that some 40 per cent of green claims made online fail to stand up to scrutiny. Apart from the obvious ethical, environmental and social effects these false claims will have, free riders gain unfair competitive advantage over responsible companies.

But, if discovered, reputational risks and legal liabilities for these companies can also be very large indeed.

Perhaps the most dramatic recent example was the Volkswagen ‘dieselgate’ scandal. This erupted in 2015, when the company was found out for systematically gaming US Environmental Protection Agency NOx emissions tests on ‘eco-friendly’ diesel cars using ‘defeat’ software. This meant the emissions performance of the affected vehicles was up to 40-fold worse than declared. Volkswagen has since paid out over €30bn in refits, legal fees and settlements.

Other less dramatic but damaging recent brand half-truths and greenwash revelations include oil companies burnishing their green credentials through modest diversion of capital to renewables and small-scale carbon capture and storage (CCS) projects that arguably act more as a fig leaf for the continued expansion of fossil fuel production, rather than having any significant impact on carbon emissions. Worse still, CCS is often associated with enhanced oil recovery.

In the airline sector, three RyanAir ads claiming relative superiority compared to other European carriers on carbon emissions per distance travelled were banned in 2020 by the UK’s Advertising Standards Authority (ASA) as potentially misleading because ‘the basis of the claims had not been made clear in the ads and that the evidence provided was insufficient to demonstrate that Ryanair was the lowest carbon-emitting airline on the basis of that metric’.

In addition, a comprehensive analysis published in Tourism Management journal by Mireia Guix, Claudia Ollé and Xavier Font, examined green claims made by airlines in 2021 on the use of voluntary carbon offsets (VCOs), and found plenty of scope for confusion. It judged 56 per cent of website claims to be trustworthy and 44 per cent to be misleading, with airlines frequently employing a confusing mix of the two. VCOs can offer efficient emissions reduction, but vary widely in efficacy, with some having serious wider environmental impact. Additionally, there’s a lack of standardisation in reporting and methodology that companies can exploit. Agreement on a rulebook for voluntary international cooperative emission reduction mechanisms, reached at the COP26 climate talks in November, may yet raise standards.

Black swans and unicorns

In the ESG financial sector – where regulations are less mature – risks could ultimately be even more far-reaching at a systemic level. The UK’s Financial Conduct Authority (FCA) has received ‘a growing number of low-quality authorisation applications from ESG-themed funds, many of whose sustainability claims did not stand up to scrutiny’. Additionally, a survey by Quilter Investors in May revealed greenwashing as the stand-out concern for some 44 per cent of investors that opted for ESG investments. Greenwashing dominated concerns in the 2021 Schroders Institutional Investor Study, in which 60 per cent of ESG investors cited it as a challenge.

As ever more manufacturers and investors rush into the lucrative sustainability space, both advertising standards and financial regulators are under increasing pressure to control harmful greenwash, and to raise standards and awareness generally. The International Organisation of Securities Commissions (IOSCO) called in November for regulators to consider more robust requirements for product-level sustainability exposure to protect the market.

In the UK, the ASA announced in September that it had reviewed its policy on green claims, and as a result revised advertising guidance is to be issued, both to cut greenwash and to help businesses get their advertising right.

Priority issues the ASA has selected for research include aviation, cars, waste, animal-based foods and heating, but also consumer understanding of carbon neutral, net zero, and hybrid vehicles. ‘We’re signalling that we intend to go further, to crack down on misleading and socially irresponsible environmental advertising and to do so in the context framed by Government and key priorities identified by experts,’ it warned. On a more positive note, it stressed that ‘Expectations are rising for businesses to play a more prominent role in encouraging responsible consumer consumption behaviours’.

But while fines are vital in discouraging the worst excesses, responsible businesses and regulators in the EU and UK have concluded that stronger regulatory frameworks based on common standards are necessary to dispel confusion as, post-Paris Agreement, sustainable investment mushrooms. To do so, these frameworks must draw on the best of voluntary initiatives and enhanced corporate reporting.

Taming the Wild West

A key development at COP26 has been the launch of the International Sustainability Standards Board (ISSB), consolidating many rival standards into one that’s widely recognised. This followed ground-breaking, high-level work on building climate-related risk reporting into the international financial system through the Task Force on Climate-Related Disclosure (TCFD). This Task Force was launched in 2015 by the Financial Stability Board (FSB) and is led by former Bank of England governor Mark Carney.

TCFD recommendations have since been adopted in guidance by both the EU and UK on corporate governance and disclosure of material risks and opportunities in an increasing range of companies, banks and investors. This has been achieved in the UK through the Bank of England and the Companies Act, and in the EU through the Non-Financial Reporting Directive, but also in parallel by Banque de France-hosted Network for Greening the Financial System. Chaired by Frank Elderson, an executive board member of the European Central Bank, the Network is a voluntary international scheme promoting accelerated private investment and the sharing of best practice on reporting and risk management, and comprises 100 central banks and supervisors on five continents, covering 85 per cent of global emissions. 

The EU has led the world in pioneering policies aimed at the redirection of investment flows into genuinely sustainable activities in its rapidly emerging green economy, through adoption of the European Green Deal in 2019, backed by a €1trn+ European Green Deal Investment Plan and sustainable finance strategy. Another key part of the package is a regulation on financial disclosures relating to sustainable investments, including how turnover, capital expenditure and operating expenditure are calculated and allocated to the company’s different activities, and if applicable, how these activities are classified as environmentally sustainable.

A European Green Bond Standard (EUGBS) and benchmarking criteria for climate and ESG investments will also help drive up standards.

But it’s the EU taxonomy classification system, which defines environmentally sustainable economic activities for companies, investors and policymakers, which will be crucial to the success of this framework. Launched in 2020 for companies, investors and policymakers, ‘it should create security for investors, protect private investors from greenwashing, help companies to become more climate-friendly, mitigate market fragmentation and help shift investments where they are most needed,’ according to the European Commission, and is already replacing the voluntary guidelines known as the Green Loan Principles. But the gap between current practices in the finance sector and the taxonomy is huge, with a lack of both sustainability skills and data, so a bumpy ride is likely early in this transition.

There’s also intense debate over whether asset classes that provide partial sustainability improvement should be included in the EU’s taxonomy. For example, nuclear power is decidedly low-carbon but has unresolved fuel cycle and other concerns, and there are calls to include natural gas with CCS potential. Whatever the merits, their inclusion in the green taxonomy could damage ESG credibility and market unity, the very systemic risks that the taxonomy is intended to avoid. This has prompted legal threats from EU Member States.

The UK was heavily involved in the taxonomy prior to Brexit, and now pursues a parallel approach to sustainable investment, with the City of London a global pioneer. In 2021, the UK became the first G20 country to mandate TCFD-aligned reporting in companies and financial institutions, and is to give them a fiduciary duty to have regard to climate risk in decision-making.

Speaking at COP26, Nikhil Rathi, CEO of the UK’s FCA, noted that the government’s Roadmap to Sustainable Investing, published in October, ‘clarified that proposed new whole-of-economy Sustainability Disclosure Requirements will build on the UK’s roll-out of TCFD’ and confirmed ISSB standards are to form the backbone of corporate reporting in the framework.

Rathi said ‘we can’t let this greenwashing persist and risk the flow of much-needed capital to help secure our futures’. He added this was why he is prioritising regulation of ESG issues, had put chairs of fund managers on notice that they ‘need to do a better job to justify and evidence their products’ ESG credentials’ and why the FCA will be challenging companies as they submit funds for authorisation.

Josie Murdoch is Senior Policy Officer at UK green business NGO Aldersgate Group. She welcomes new policies on sustainable finance that ‘will increase standardisation of reporting and availability of data around climate-related financial risk, both of which will help tackle greenwashing and make it easier for investors to understand the level of risk involved in a company’s operations’, along with transition plans.

But Murdoch also points out that UK policies such as the Sustainability Disclosure Requirements and the UK Green Taxonomy need to be aligned with international policies such as the EU’s Sustainable Finance Disclosure Regulation (SFDR), the EU Green Taxonomy and Paris Agreement rulebook ‘to reduce [the] reporting burden and make it easier for investors to compare risks and strategies across jurisdictions’.

The role of lawyers

These are of course all areas where corporate lawyers are increasingly engaged, with IBA members again playing key roles. Lawyers need a clearer definition of greenwash and of sustainability, and more standardisation to operate successfully for clients and in the public interest.

Roberto Randazzo is External Communications Officer on the IBA Business Human Rights Committee and a partner with Legance Avvocati Associati in Milan, with a particular interest in ESG, impact and sustainability. He is the outgoing President of esela – the global legal network for social impact.

Randazzo is a firm supporter of stronger corporate legal frameworks moving beyond ‘soft law’ to protect the ESG economy. ‘We need rules and we need protection of this ecosystem in order to avoid greenwash […] the risk to avoid is another bubble for financial investors.’

Currently he considers ‘we’re on the way, working towards a clearer system of KPIs, measurement tools, but it’s not complete at present’. With so many different tools available, there’s ‘confusion, [a] lack of transparency and [a] lack of standardisation,’ he says. Randazzo adds that ‘we have to move from a passive approach to a positive approach,’ one linked to a more strategic vision for investment and that’s based on access to relevant data, KPIs, ESG or impact results, rather than merely generating reports.  

Randazzo believes the emerging ESG and impact economy in the EU must be built on three pillars. The first covers financial investors, based on the Non-Financial Reporting Directive 2014/95 (which will be amended by the upcoming Corporate Sustainability Reporting Directive) and the SFDR.

The SFDR ‘was the turning point for investors and financial operators’ who must explain their sustainability using clear ESG metrics, KPIs, or declare they are not promoted as having ESG elements or objectives. But he stresses the bar is higher for impact investors than ESG, in that ‘you also have to declare if your investment is aimed at introducing an impact result’.

The second pillar is about sustainable value chains, meaning that companies will have to identify and assess the potential impact on ESG issues in their business relationships (a draft EU Directive on corporate due diligence and accountability was released in March).

'Finally, the EU Sustainable Governance Directive – which is expected by the end of 2021 – will complete the framework setting the rules to better align directors' duties with the interests of shareholders and stakeholders,' says Randazzo.

The three pillars, he says, need a clear taxonomy defining what sustainability is, to be considered as ‘the cornerstone of this whole system in the EU’. Despite considerable progress, he notes ‘the problem today is that we are too much focused on the “E” of ESG with a clear regulatory framework on how to evaluate environmental/green investment, [but there’s] not enough [focus on] “S-social”, and “G-governance”.’ 

Embedding corporate sustainability

Caroline Phillips is European Regional Forum Liaison Officer for the IBA Banking Law Committee and a partner at Slaughter and May in London, working on public debt capital market issuances, loan financings and structured finance and sustainable finance advisory. She has seen major, accelerating change. ‘Whilst I’ve been working with clients on green and ESG products for at least half a decade, at the beginning it was just the likes of Drax [power station] who were going through a transition from coal to biomass and for the future viability of their business they really needed to look at this. Now I find it widespread and I think the conversation’s really changed.’

‘Five years ago I would have been very cynical about some of the bonds being issued and sustainability work being done, and there was certainly an element of greenwashing,’ explains Phillips. ‘But responsible business now has moved beyond that, and so there’s little scope for greenwashing and the reputational risk associated with greenwash are things that most of my clients anyway are not willing to contemplate.’

She says her clients at least are ‘extremely focused on doing it properly […] And they have sustainability teams who are looking at it. They’re thinking about their targets, their stretch targets, it’s important reputationally for them to be seen to be doing things and doing it well.’

Now investors are saying ‘it’s not good enough to have a questionnaire, you need to have KPIs, you need to be able to articulate them and tell us what they are and how you’re going to meet them […] I’d say 80 per cent of the loan products that I’ve done this year have had ESG, KPIs in them’.

Phillips considers businesses now have to take sustainability seriously, due to regulatory drivers now in force in Europe, and in the UK ‘where premium-listing companies have disclosure obligations around it […] [In November] we saw new disclosure obligations for insurers, asset managers and the like as well’. 

On the question of whether the EU and UK taxonomy further embeds sustainability and drives out greenwash, Phillips is less convinced. ‘They’re helpful,’ she says, ‘and do help people talk to a common set of standards […] but I don’t think they move the needle that much further forward than the International Capital Markets Association principles or the Loan Market Association principles as best practice.’

‘Stakeholders’ actions and requirements, coupled with everyone understanding the principles that people should use, drives the discussions more,’ she says, with lawyers mediating discussion and ‘acting as a bridge in terms of translating strategy into action,’ though taxonomy does highlight sustainability and greenwash issues.

Phillips accepts criticisms that sustainable finance products have no real contractual obligations if there is a failure to meet KPIs or not deploy proceeds as proposed. She adds however that these objectives must be clearly articulated, or failure risks access to the capital markets being ‘severely hindered and the reputational damage will be significant’.

One way of driving ESG through in the UK is reform of s 172 of the country’s Companies Act 2006. Phillips considers that the current law ‘is probably broad enough to encapsulate the more holistic approach that companies are now taking […] But the view of the people in senior positions in most businesses I’ve spoken to is that actually it’s helpful for the law to spell out more clearly better business objectives, even if that makes it less flexible for future developments and change’.

‘But where I’m hoping all of this will end up is that businesses that don’t operate in a sustainable fashion will find it difficult to be financed,’ she adds.

Future perfect?

Product and corporate performance greenwash now has a long history, but with sustainable investment flows accelerating post-Paris Agreement, transparency, data quality, carbon disclosure and standardised sustainability reporting are vital in de-risking the ESG sector for investors. Legislation and case law in the EU and UK is also advancing, along with a taxonomy framework, increasing potential corporate exposure to legal challenge and reputational risk from greenwash and lower quality green investments, while the US emphasises transparency through voluntary reporting.

Systematic regulatory approaches to ESG have many advantages, but not if they become mere tick box exercises, and the risks from failing to adequately assess social impact are now considered substantial.

Corporate lawyers can expect to be increasingly engaged in each of these aspects, dependent on region, whether in advocacy, product litigation, risk management, compliance issues, or proactively designing better voluntary or regulatory frameworks. New systemic risks to the sustainable economy from low-quality transitional asset classes are also on the legal agenda, as are debates on nuclear’s inclusion in sustainable taxonomy.