Why greenwashing in the financial sector is a risky business

A globe-shaped balloon during a rally in Rome ahead of the 2015 Paris climate conference in 2015. Reuters

With 2023 heralded as the UAE’s “Year of Sustainability”, there is much to look forward to, plan for and act on. Cop28 President-Designate Dr Sultan Al Jaber stated that the UAE is committed to making this year’s climate conference “a Cop of action” in his very first speech, and the UAE Net-Zero plan is now guiding all our collective actions to achieve net-zero emissions by 2050. Around the world we are seeing increasing pressure on leaders to act and address the threat of climate change.

As global awareness of the impacts of climate change continues to grow, consumers and investors are seeking – and, in some cases, demanding – sustainable products and socially responsible investment opportunities to drive positive change. This impending need for change has created top-down pressure for financial market participants to act swiftly. Combined with the bottom-up pressure from investors and consumers, this is expected to bring significant growth in sustainability-related investments in global markets in the next few years. Though this is welcome news, an unfortunate knock-on effect of this drive has been an increase in both the risk and incidence of greenwashing.

Greenwashing refers to claims by an organisation that misrepresent the sustainability features, action or impact of its activities, practices or products. In the financial sector, greenwashing can affect a myriad of financial markets participants across the value chain of sustainable investments and sustainable products. It varies in scope and severity from confusing or inappropriate use of sustainability-related terminology to deceptive marketing practices and outright fraud.

Combatting greenwashing involves efforts from all sides to ensure that it becomes a practice of the past

The financial sector faces growing scrutiny from its stakeholders as shareholders and regulators seek assurance that all declared sustainability-related actions, decisions and products can be clearly demonstrated as having the stated positive contributions. The risk of greenwashing increases when organisations cannot demonstrate clearly and unequivocally that their actions, decisions or products have a measurable impact on sustainability as stated, for example, in their disclosures, reports or product documents.

One critical element to consider when weighing the risk of greenwashing is “additionality”. In the absence of specific taxonomies, industry decarbonisation or environmental pathways, a company’s action, project, or product should be labelled “green” only when it can demonstrate its effective contribution towards lowering carbon emissions and when such reduction is additional to what would have happened regardless of the project happening.

Greenwashing can have a wide-ranging impact on the success and integrity of sustainability-focused financial markets, the soundness of financial firms and the stability of the wider financial system, as well as on investor protection and consumer confidence. At its worst, it can reduce trust in sustainability-labelled financial products and, as this trust erodes, any attempts to address climate change are undermined.

Transparency is key to preventing greenwashing. Clear and relevant disclosures are a primary safeguard for investors and consumers to ensure the information they receive is sufficient for making informed decisions.

Environmental, social and governance (ESG) verification and certification bodies, as well as data providers, are increasingly being relied upon to provide insight to investors, regulators and the public.

Coupled with disclosure is the need to educate investors and other market participants about greenwashing and how it can be identified and addressed. The responsibility for this lies with the financial industry, regulators and other public bodies. Although knowing how to identify greenwashing will not necessarily prevent it, more awareness among market players, including investors and consumers, may help them avoid being blind-sided by attractive looking but empty “green” claims that do not hold true.

The DFSA has taken steps to raise awareness among market participants about the risks of greenwashing. In November, we issued a Markets Brief outlining best practice guidelines for issuers on the Dubai International Financial Centre markets when issuing ESG bonds and sukuk. In April, another markets brief emphasised ESG-related disclosure considerations for issuers and reporting entities under the DFSA rules. We are actively engaging at national and international levels to help develop global frameworks on ESG matters that seek to minimise greenwashing practices by bringing more transparency to this area.

Ultimately, combatting greenwashing involves efforts from all sides – not only from the public sector, including regulators, but also from the corporate and financial sectors, investors and consumers – to ensure that it becomes a practice of the past.

The need for an active sustainable finance market to help finance the transition to a zero-carbon economy is great. Tackling greenwashing requires a concerted effort from both the public and private sectors to ensure finance flows towards the projects, products and services that are the most efficient and effective in helping us achieve net-zero emissions.