The EU takes steps to combat greenwashing in finance
Investment flows into sustainable strategies have accelerated, amounting to trillions of euros in Europe alone today . This in turn has led to the rise of “greenwashing” in finance, the misrepresentation of investment products that makes them appear more environmentally sound than they are. To tackle such greenwashing in the financial industry, the EU is defining stricter standards around mandatory disclosures and setting minimum standards for such products to qualify for the sustainable designation. These new changes will also provide a common language around responsible investing.
From the 10th of March of this year, all asset managers with European operations must align usage of and provide appropriate disclosure around their solutions marketed as sustainable or ESG . This Sustainable Finance Disclosure Regulation is meant to clearly distinguish traditional from responsible investing solutions. Traditional here means investment decisions are not made based on extra-financial considerations, with a sole focus on financial returns.
ESG-integrated strategies take into account ESG factors and sustainability risks as an additional lens to traditional financial analysis. Products classified as ESG-binding go one step further by not only including ESG analysis into the investment process, but also actively selecting those companies with better ESG metrics and excluding certain controversial activities in order to promote environmental and social characteristics. ESG-binding solutions that hold companies with poor ESG scores should be able to demonstrate engagement with these companies through active dialogue and proxy voting, in an effort to improve in these areas.
“Under this new regulation, investment solutions labelled as positive impact must have a sustainable investment objective and deliver positive social and/ or environmental impact.”
Under this new regulation, investment solutions labelled as positive impact must have a clear sustainable investment objective and deliver positive social and/or environmental impact. In other words, these sustainable products must go beyond “avoiding the bad” and select companies that make active contributions towards a better future. This is how many impact investments - those that put equal emphasis on delivering both positive impact and financial returns - will be classified.
Currently in the works is an EU taxonomy that will serve as an additional step in bringing clarity and discipline amidst the current alphabet soup of sustainable acronyms and labels. The Taxonomy Regulation establishes six environmental objectives. The implementation roll out is expected to begin early next year and will help us to all understand better where our money is going when investing in environmentally sustainable products.
The Taxonomy Regulation establishes six environmental objectives
- Climate change mitigation
- Climate change adaptation
- The sustainable use and protection of water and marine resources
- The transition to a circular economy
- Pollution prevention and control
- The protection and restoration of biodiversity and ecosystems
This will serve as more than a regulatory framework that help end investors avoid being misled. It is also intended as an implementation tool for the European Green Deal. By introducing common definitions around environmental sustainability, companies and policymakers can better plan for the transition to a carbon-neutral, circular economy in which no one is left behind. Regulation around disclosure requirements will likely come into effect over the next years.
Beyond this year, we can expect the taxonomy’s development to aid in the creation of fund ecolabels and green bond labels. We expect this to come sometime in 2023 and help to harmonise the plethora of labels now in use that often differ in application and lack clarity. In the long run, this will aid in the selection of financial products that are aligned with client needs and preferences.
Putting investors at the centre
“This will in effect empower European investors – by providing them with the explicit options and holding investment companies accountable for upholding them.”
Looking out to the end of 2022 or 2023, the EU has proposed regulatory changes that will require investment professionals to take client ESG preferences into account when offering investment advice or taking investment decisions on their behalf  . These will become part of the already required “suitability assessments” that such financial firms are already obligated to make regarding client risk appetite and financial knowledge and objectives.
The European Commission has defined ‘sustainability preferences’ as a client’s or a potential client’s choice as to whether products that have sustainable investments as their objectives or that promote environmental or social characteristics should be integrated into their investment strategy.
What this means for European investors is that their financial advisors and managers will be required to both solicit their preferences around how their investments align with sustainability and to act accordingly. This will in effect empower European investors – by providing them with the explicit options and holding investment companies accountable for upholding them. In conjunction with the EU’s other sustainable finance measures, it should bring clarity and consistency to the sustainable finance market that is currently lacking.
 Source: Candriam, 2020;  Source: Environmental, social and governance;  Source: European Commission;  Source: Deloitte, 2020