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Greenwashing: ESMA revised guidelines and new UK rules

This article first appeared in Thomson Reuters Regulatory Intelligence. 

Few subjects in finance are as complicated and emotive as ESG (environmental, social and governance) investment. Consumers are looking for simple phrases telling them that a product is "good" but these messages can be a greenwash of misleading or unsubstantiated claims. The EU and UK are introducing anti-greenwashing measures, some taking effect this spring, so firms should review how they name and promote funds. 

Strong demand, competitive market 

There has been push-back in the United States but ESG investments, especially related to climate change, are popular with European institutional and retail investors. Sixty-eight percent of UK pension funds are committed to net zero carbon emissions alignment and 56% of the wealth manager deVere's clients intend to increase their allocations to ESG investments in 2024. ING expects 40% of ESG bonds issued globally this year to be euro-denominated. 

Strong demand has produced a busy and competitive market. Firms want their products to look attractive; investors want pointers to funds that match their expectations but European regulators have conceded that consumers struggle to understand disclosures under the Sustainable Financial Disclosure Regulation (SFDR). That makes snappy ESG messages and eco-buzzwords attractive for firms and consumers but has led to a rise in greenwashing. 

Last May, a report by the European Securities and Markets Authority (ESMA) defined greenwashing as "a practice where 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 service. This practice may be misleading to consumers, investors, or other market participants." 

The same ESMA report analysed where and how greenwashing risks arise in the sustainable investment value chain. This confirmed that misleading claims can relate to any major aspect of a product's sustainability profile, including its ESG strategy, policy and credentials, its impact and the performance metrics and targets used. The most widespread forms of greenwashing were omission, ambiguity, exaggeration and, most importantly for retail investors, names using misleading ESG terminology. 


This presents particular problems for the EU because its green finance regulatory package does not include a product-labelling regime, but consumers want labels. Firms have been using SFDR articles 8 and 9 disclosure categories as stand-ins, which 66% of attendants to an ESMA webinar on the issue said increased the risk of greenwashing. 

ESMA is consulting on introducing labels as part of an SFDR revamp (SFDR 2) but that will take time. Furthermore, the finalised Green Claims Directive COM(2023)166, expected to enter into force this spring, will not apply to financial services or products. A dedicated greenwashing regulation for finance may follow ESMA's final report on the issue due in May, but meanwhile it plans to reduce the problem via fund name guidelines.

ESMA opened a guidelines consultation on fund names using ESG or sustainability-related terms in November 2022. In December 2023, however, it issued a statement making post-feedback changes to the proposed guidelines and postponing their adoption. 

The revised guidelines will require a fund with any ESG-related words in its title to use at least 80% of its investments to meet its ESG or sustainable investment objective, in effect barring SFDR article 6 funds named using ESG terms. A requirement that funds named using "sustainability-related" words would also have to invest at least 50% in sustainable investments was dropped, but they must still "invest meaningfully" in them. 

Other guideline revisions accommodate funds whose strategies focus on the transition to a greener economy. A new category for "transition-related" terms was introduced, again requiring an 80% investment threshold. Other changes were made to avoid unduly restricting the fossil fuel investment options of funds with "social" or "governance" names and objectives. 

"There are certain bolt-on requirements that apply depending on what specific terms you use in your product's title," said Terry Yiangou, a managing associate in the law firm Linklaters' financial regulation team. "By way of example, if you use the term 'sustainable' or variations thereof, you must also apply the Paris-aligned benchmark (PAB) exclusions; so if you use the term 'transition' or related terms, you must also apply Climate Transition Benchmark (CTB) exclusions." 

UK Sustainability Disclosure Requirements  

The UK moved more slowly on green finance than the EU but Financial Conduct Authority (FCA) policy statement PS23/16 introduced a Sustainability Disclosure Requirements (SDR) regime complete with investment labels and naming and marketing restrictions in new handbook chapter ESG 4.3. These include a general anti-greenwashing rule ESG 4.3.1, coming into force on May 31, 2024. 

"Of the SDR's various incoming obligations, the anti-greenwashing rule will have the widest scope of application, biting on all FCA authorised firms in relation to any sustainability-related claims they make concerning not only their products but services too," Yiangou said.

"Compliance will involve ensuring that any reference to the sustainability characteristics of a product or service is a) consistent with the sustainability characteristics of the product or service; and b) fair, clear and not misleading." 

The FCA is consulting (GC23/3) on guidance about the anti-greenwashing rule. The draft guidance accepts there is no single definition of "sustainability" but follows the FCA's approach to governance in PS23/16 (which said it was an enabler of environmental or social outcomes, not an end in itself) and says references to "sustainability characteristics" mean "environmental or social characteristics". GC23/3 fleshes out the anti-greenwashing rule by saying, at paragraph 13, sustainability claims should be: 

correct and capable of being substantiated; 

clear and presented in a way that can be understood; 

complete, in that they should not omit or hide important information and should consider the full life cycle of the product or service; 

fair and meaningful in relation to any comparisons to other products or services. 

The SDR also contains specific naming and marketing rules, which relate to its four labels for sustainable investment products. These are: 

"Sustainability Focus" (a 70% sustainable investment threshold) 

"Sustainability Impact" (has an explicit objective to achieve a measurable positive contribution to sustainable outcomes) 

"Sustainability Improvers" (investment in assets with the potential to improve their sustainability) and

"Sustainability Mixed Goals" (product mixes aspects of the other three labels). 

Under new naming rule ESG 4.3.4(2), if a fund uses the Sustainability Focus, Sustainability Improvers or Sustainability Mixed Goals labels, it cannot use the word "impact" in its name. 

ESG 4.3.2(2) lists 12 words commonly seen in greenwashing, such as "green", "climate", "ESG" and "environment", and has a catch-all clause covering any other term implying a product has sustainability characteristics. The FCA had proposed banning products without a sustainability label using such terms in their name or promotional material but this was dropped. Instead, ESG 4.3.5 allows them to use such terms subject to restrictions. 

"The terms 'sustainable', 'sustainability' or 'impact' are forbidden; the fund cannot suggest it has an SDR label, and must state that it doesn't have a label and explain why," Yiangou said. "The fund must ensure that the ESG term used is appropriate for the strategy and composition of the product, so it reflects the product's sustainability characteristics, per the anti-greenwashing rule."

 (Tim Hitchcock, Regulatory Intelligence, 25 January 2024)


eu, uk, usa, sustainable finance