Greenwashing is becoming an increasing regulatory concern in the UK, EU and globally following the rise in demand for sustainable investment products. Greenwashing occurs when asset management firms make misleading or unsubstantiated statements about environmental performance of financial products. It is important to note that even in the absence of deliberate misconduct, greenwashing may still arise if the sustainability data that is used to make investment decisions is non-standardised, or the communication from the firm around their sustainability terminology is unclear.

Greenwashing can occur at the firm as well as the fund or product level. This report focuses on the latter. The Financial Conduct Authority (FCA) has committed to identify and intervene where they believe greenwashing has occurred. The responsibility for addressing the risk of greenwashing is captured in the firm’s compliance and risk functions, as well as strategies around sustainable investing. FCA and EU regulators expect that firms will take a holistic approach in involving all relevant functions across each stage of product development in order to avoid greenwashing.

Key regulatory initiatives that have emerged include the EU’s Sustainable Finance Disclosure Regulation (SFDR). This aims to reduce information asymmetries and create transparent sustainability disclosure to protect investors. This has been implemented since 2021 with additional standards anticipated to emerge in 2023. Additionally, the FCA released a Dear AFM Chair Letter in July 2021 containing guidelines to prevent greenwashing at all levels for sustainable funds. The FCA published a discussion paper on required sustainability disclosure for investment products in the UK in November 2021. These disclosures include: a consumer facing product level disclosure for retail investors; detailed disclosures on data limitations and sustainability risk for institutional investors; and, a five-pronged labelling regime for all investment products to display the level of sustainability the product has.

This report outlines five key steps that firms can take to avoid greenwashing. Firstly, firms should ensure there is appropriate due diligence on third party sustainability data, and ensure there is transparency around data limitations and the emergence of new sustainability data that could impact the funds ability to perform on sustainability objectives. Secondly, firms must ensure their fund-specific documentation and firm-wide sustainability polices are communicated in an easily digestible way for all investors. Thirdly, firms must ensure they provide thorough fund documentation that draws clear links between fund names and sustainable objectives, as well as information about the firm’s stance on sustainable investing and data limitations. Furthermore, firms must provide end-investors with on-going reporting of fund information to ensure investors can assess whether the fund is meeting the sustainable objectives. Finally, firms must ensure compliance officers are trained in sustainable investing to determine whether greenwashing has occurred. There should be robust analysis whether a situation triggers the definition of an FCA complaint and, in turn, must be handled in a serious manner.

Ultimately, firms must make a collaborative effort and follow the key steps discussed, to remove the potential for confusion and exaggeration around sustainable investing, and mitigate greenwashing risk.

1. Recent years have seen a significant increase in the number of funds that describe themselves as sustainable, with new funds (both active and passive) being launched every week following rising investor interest, particularly in the UK and EU.
2. Assets in funds that have sustainable objectives or promote environmental or social characteristics reached EUR 4.05 trillion at the end of December 2021, representing 42.2% of all funds sold in the EU.
3. As asset management firms face pressure to remain competitive in a growing market, they are at risk of over exaggerating the sustainable benefits of their products.
4. Asset management firms must take a holistic approach to prevent greenwashing from occurring.
5. Greenwashing can still arise even in the absence of deliberate misconduct.
6. Greenwashing can occur at the firm as well as the fund or product level.
7. Greenwashing (or claims of greenwashing) can arise for reasons such as incomplete data or new and unfamiliar terminology, and firms will need to incorporate controls against this happening into their overall risk management frameworks.
8. Responsibility for addressing the risk of greenwashing extends well beyond firms’ compliance and risk functions.
9. Firm and fund boards will need to consider greenwashing risk in the context of setting firm-wide and fund specific strategies for issues such as sustainable investing and the use of sustainability data from third parties.
10. Greenwashing is high on regulators’ agendas and new disclosure regimes are intended to foster trust in sustainable investments and facilitate efficient capital allocation in the long run.