Industry
Banking
Banking Services Transformation: Unlocking Exponential Value
Solution
Sustainability Services
Ecosystem-led Approach to Power Your Sustainability Strategy
Highlights
- With growing demand for sustainable investments, greenwashing has become a significant concern, leading to increased scrutiny, regulatory attention and legal challenges within the financial industry sector.
- Risk management of greenwashing is implemented effectively when defined at entity, product or client level.
- Eliminating greenwashing in the financial industry requires a combination of regulatory compliance, industry-wide standards, transparency, and active stakeholder engagement.
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Action against Greenwashing
Greenwashing is becoming increasingly common in the financial services industry with a significant increase in misleading sustainability claims and associated levels of litigation.
A stark illustration of the perils of greenwashing is DWS, which risks becoming the poster child for regulatory action against greenwashing. Originally raided by the Regulatory Authorities in 2022, along with the headquarters of its majority owner Deutsche Bank, DWS paid the US authorities a $19m fine for alleged misstatements regarding its ESG investment process. DWS was raided again twice in late January / early February this year by the German prosecutor with investigations ongoing and could also face a substantial fine in Germany, as well as investor claims for damages. The alleged failings by DWS were not minor, with a 75% fall in the assets labelled as Green, because of updating the internal ESG labelling criteria.
DWS is by no means alone. Last year the European Banking Authority (EBA) found the alleged greenwashing cases in the EU financial sector had increased significantly in the most recent years with around 206 cases reported in 2022 against 40 in 2018.
Figure 1: Greenwashing Litigation
It’s not just regulators that are on the case, civil activism over the last few years has included direct action against banks targeting their headquarters and erecting billboards attacking their corporate image, or popular brands with which they are associated.
Investors too have targeted banks over gaps between their stated strategies and their activities with an uptick in AGM motions criticizing net zero plans amongst other commitments. Board members ignore this at their peril with the directors of Shell sued personally in 2023. Although this action was not successful, the case demonstrates how high the stakes have risen.
Brand value is often much higher than asset value so brand perception really matters. As greenwashing becomes the go to accusation of hypocrisy against large corporations and financial institutions, the impact on value can be significant. Moreover, in the age of social media it’s much easier for accusers to spread accusations whether true or not. Social media users tend to believe what’s posted by individuals and not believe facts from official or large organisations. Once a story is out, the genie doesn’t get back in the bottle and firms can’t control messaging via traditional media strategies.
Which brings us to Trust. Greenwashing is an emotive term that the public understands without knowing the details. Greenwashing is seen as a form of lying, which feeds the perception held among large swathes of society, that financial institutions (and other large firms) can’t be trusted. As has been demonstrated many times, particularly in banking, trust is critical and once lost can be catastrophic.
Types of Greenwashing
To implement effective risk management of greenwashing it is necessary to define it more specifically. It is helpful to note that greenwashing can manifest at any entity, product or client level.
A. Entity-Level
Entity-Level greenwashing, relating to business strategy, is the most common type of(alleged) greenwashing in the banking sector. A few common examples, include:
Publishing strategic statements and/or sustainability policies but systematically continuing to provide finance to invest in companies that breach these. Significant ongoing financing to the fossil fuel industry (that excludes financing of sustainable transition of those companies) is the most common allegation which is inconsistent with published net-zero emission targets e.g. firms building coal-fired power plants. Other examples include financing of firms associated with deforestation, accused of human rights violations or projects with serious negative social and environmental impacts.
Publishing net-zero emission targets which are not supported by an evidenced or credible transition plan. Related activities include cherry-picking and using different net zero scenarios for different purposes (e.g. internal and external).
Removing information critical to greenhouse gas emissions whilst making claims regarding its efforts to alleviate climate change. Highlighting sustainable initiatives while withholding information on non-sustainable funding and downplaying negative sustainability impacts:
Pretending to embrace an ESG culture but failing to integrate it into the entity’s governance, management practices, and staff policies. This would commonly lead to failure to implement control structures or conduct due diligence.
Cultural issues have also been identified by the mismatch of public statements and the accusation of ongoing lobbying against climate policies in Europe, the UK, and the US. Perversely if successful this lobbying would usually undermine firms own net-zero carbon commitments.
B. Product-Level
Most alleged cases at Product-Level to date relate to investment products, like at DWS, and accordingly regulation has sought to be specific on related requirements as well as including general greenwashing provisions e.g. the anti-greenwashing rule in the UK FCA’s Sustainability Disclosure Requirements.
Alleged Greenwashing generally relates to misleading statements regarding either:
The current sustainability characteristics of products and associated misleading labelling e.g. sustainably marketed investment funds with an inconsistent investment profile/strategy or green loans without restrictions / tracking of the use of the funds.
The sustainability outcomes and tangible impact of products e.g. promoting funds as ‘sustainable’ while they invest in companies having adverse socio-environmental impacts, or sustainability linked loans that don’t penalize firms meaningfully for not achieving their targets.
C. Client-Level
Allegations at client-level generally relate to misleading claims made because of:
A firm’s relationships with a client, this could be a deep relationship with a (materially non-transitioning) fossil fuels client that is preserved due to profitability, or
The transactions they undertake with them where the sustainability commitments or required performance to gain the economic benefit from implementing improved sustainability practices are misrepresented.
Combating Greenwashing
Eliminating greenwashing requires both cultural change and alignment of sustainability communications.
Change needs to be firm-wide, with credible evidence of changed practices across all core business activities.
Figure 2: Firm-wide Embedding
Financial institutions that implement substantive measures across these areas can simultaneously improve their risk management and demonstrate authenticity in their green or net-zero credentials. As society’s views change, what is acceptable today can become unacceptable quickly and a proactive approach is necessary, irrespective of the effectiveness of current controls.
What to Do Next: Greenwashing Scenarios
There is one area above in particular that firms have struggled with, creating meaningful greenwashing scenarios.
Below I recommend a 3-step approach to identify and improve understanding of potential vulnerabilities, using greenwashing scenarios to drive insights, which are then used as a basis for the design of robust Greenwashing Risk Management processes.
A. Create a Greenwashing Taxonomy
A Greenwashing Taxonomy provides a structured approach to analyzing the risks, my approach includes detailed examples under the following 6 categories:
- Values misalignment
- Misrepresentation
- Failure to deliver/underperformance
- Strategic missteps
- Crisis mismanagement
- Lack of reliability/competency: Climate-related ORM losses
B. Create Reverse Scenarios for Greenwashing
To recap, trust is paramount in financial services, greenwashing can lead to loss of trust, which in turn can be catastrophic. Reverse scenarios consider exactly this problem, by identifying scenarios where the firm loses its Social License to Operate (SLO), we can boost understanding of vulnerabilities.
Using the above taxonomy to anchor (but not limited to) thinking, this technique involves working backwards from an extreme negative outcome e.g. major brand damage, serious regulatory sanction, and looks for severe, but possible scenarios and conditions that could lead to this outcome.
As quantification or likelihood of scenarios aren’t constraints, reverse scenarios are a creative yet rigorous approach to reveal vulnerabilities in strategy, risk management and portfolio construction. In the context of greenwashing, they can identify the most important areas of misalignment between sustainability communications and operational reality.
Reverse scenarios may be single event based or a series of events with repeat issues weakening public opinion. Any scenario is likely to include a tipping point where adverse climate event-driven media coverage including social media, gains momentum such that:
- Large commercial customers seek to distance themselves from the Bank’s tarnished climate image and by doing so create momentum for other firms to distance themselves; or
- The public seeks to ‘punish’ the bank by withdrawing funds and/or by the publicity of this there is a run on the bank; or
- The issue becomes a political matter, with non-Bank agendas driving response. May lead to making an example of the firm / punishment.
C. Design an updated greenwashing risk management framework
Using the insights gleaned from reverse scenarios, firms can create a robust, nuanced risk management framework based on:
Specific vulnerabilities within the portfolio / operations / culture which increase the risk of Greenwashing
Controls and key management information over the things that matter most, for instance identification of early warning signals and hence focused monitoring.
Conclusion
The End Game (and a parrot)
All the above brings us to tools to investigate specific vulnerabilities more deeply, which almost inevitably involves the consideration of Generative AI and what it can do to help. Gen AI has already become a powerful tool in the reputational risk space. Adding a nuanced view of what a firm is most concerned about and getting the broad sweep of internal and external information sources that Gen AI can provide can be a game changer.
Having said this, the best defense against greenwashing remains not to do it in the first place which, as with most things in risk management, comes down to culture. As a wise person once said, “Live in such a way that you would not be ashamed to sell your parrot to the town gossip.”
