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‘Green’ Investing Craze Draws Regulatory Scrutiny

European market regulators said Friday that they are “prioritizing the fight” against greenwashing amid a record boom in investment vehicles marked as “sustainable” or “green.”

The European Securities and Markets Authority (ESMA) outlined plans to crack down on misleading environment, social and governance (ESG) claims and promote transparency as part of a broader sustainable finance roadmap for the next three years.

The combination of surging demand for ESG investments and rapidly evolving markets “creates room” for greenwashing, potentially resulting in adverse impacts for investors looking to make greener choices, the ESMA said. It defined greenwashing as market practices, both intentional and unintentional, in which the disclosed sustainability profile of an issuer and the characteristics or objectives of a financial instrument of product “do not properly reflect” the underlying sustainable risks and impacts associated with that issue, instrument or product.

“Greenwashing could, therefore, be generally identified as a misrepresentation, mislabelling, misselling and/or mispricing phenomenon,” it noted in the roadmap document. “However, these terms may only represent the ultimate symptoms, since the causes of greenwashing may relate to multiple aspects of the functioning of the investment value chain, sometimes affecting nodes of that chain long before a certain financial product reaches the final investor.”

The ESMA said that it and national competent authorities would ideally be addressing greenwashing based on a “complete and fully applicable” legislative framework that demarcates the boundaries of market behavior and practices that are and are not acceptable. “However, there is now a real need to address greenwashing without delay, even if all the legislative stepping stones are not fully in place,” it said.

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Investigating the “complex issue” of greenwashing, defining its “fundamental features” and taking “coordinated action” in multiple sectors to find common solutions will be critical to delivering on ESMA’s and national competent authorities’ mandate to secure investor protection, the agency added.

Morningstar estimates that assets of funds focused on sustainable investing hit $3.9 trillion in September, almost doubling in six months despite a slowdown in flow activity in the third quarter of 2021. But bad players proliferate. Sweden’s financial supervisory authority said in November, for instance, that a scant 5 percent of 400 funds it probed made verifiable green claims. And in August, the U.S. Department of Justice said it was scrutinizing Deutsche Bank’s asset management offshoot, DWS, for potentially overstating how it used sustainable criteria to handle investments.

The European Commission recently debuted new ESG disclosure requirements, plus a sustainable finance taxonomy that governs what can be marketed as a sustainable investment. The ESMA said it will develop measures to ensure “robust disclosures” on companies’ current environmental performance, along with the transition plans to increase the taxonomy alignment of their business activities.

“Ensuring the consistent and effective application of the EU sustainable finance rulebook is key to preventing greenwashing,” it added.