The demand for sustainable finance continues to grow rapidly. The North American GSS (Green, Social, Sustainable) bond market alone has grown on average 72% a year, according to latest figures reaching a US cumulative total of $275.9bn as of Q1 2021. (Source: North America, State of the Market Report, 2021, Climate Bonds Initiative) 

While it's encouraging to see momentum around the transition to net zero in finance, the exponential growth of these markets raises questions around how pervasive greenwashing has become in the market – a concern echoed by the SEC.

In May 2022, the SEC set out a new proposal to improve disclosure in relation to environmental, social and governance investment practices. This comes hot on the heels of its decision to fine a large US investment adviser company $1.5 million for making misstatements and omissions about the ESG considerations used for investment decisions in certain mutual funds. While the firm claimed that all investments in the funds had undergone an ESG quality review, the SEC found that certain funds did not have a proper ESG quality review score at the time of investment and penalised the firm. 

This is not an isolated event. A large US bank is being questioned by investors after the risks of sustainability funds were downplayed by a senior banker, causing at least one large institutional investor to lose faith in the bank.  Meanwhile, another investment banking firm has lost credibility after multiple allegations over fraudulent ESG funds. In the wake of greenwashing police raids related to this, the CEO has resigned and the firm’s stock price has plummeted.  

These developments should cause us to pause and reflect on the complexity and challenges associated with assessing and identifying the credibility of the financial instruments and companies seeking funding – as well as underline the cost of getting it wrong.  

Our recent analysis on Sustainable Linked Loans suggests that up to half could be open to greenwashing. To what extent, then, is sustainable finance really driving the change that its name implies? And what steps should US financial institutions take to drive integrity and trust in their green products? 

Aligning to the core principles outlined in the SEC’s proposals is a positive first step that firms can take to guard against greenwashing 

Under the Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices proposal outlined by the SEC, firms would be required to:  

  1. Provide additional information regarding ESG investment strategies in fund prospectuses, annual reports, and adviser brochures 

  1. Implement regulatory frameworks in a layered, tabular approach for ESG funds so that investors can make informed decisions 

  1. Disclose the greenhouse gas (GHG) emissions associated with their portfolio investments for certain environmentally focused funds 

The rules will require different disclosures for all investment products that vary on the levels of ESG centrality in their strategies. The proposal references three different fund types that will require these additional provisions:   

  • Integration Funds (funds that integrate ESG and non-ESG factors) must disclose more detailed descriptions of how ESG factors are incorporated into their investment selection process. 

  • ESG-Focused Funds must include more detailed, streamlined disclosures with standardized ESG strategy overview tables for easy comparison between funds. 

  • Impact Funds require the same disclosures as ESG-Focused Funds, in addition to how the fund measures progress toward the specified impact, the time horizon to measure that progress, and the connection between impact and fund’s financial returns.  

The SEC also proposes an update to the Names Rule, which requires 80% of the fund’s assets to be invested in assets aligned with an ESG investment policy for the fund name to include the acronym ESG. The purpose of this rule is to prevent investors from being misled on the fund’s investments and risks.   

Ultimately the enhanced guidance from the SEC is simply asking investment companies and advisors to ensure the names of their products live up to the standards that ESG is meant to uphold. With clear and fully transparent insight into a fund’s ESG investment policies and assets, financial institutions have the opportunity to differentiate in an increasingly muddled market.   

Financial institutions must incorporate accurate and transparent ESG information that reflects the true level of impact, risk and reward. Establishing best practices ahead of mandated regulations will only serve to benefit the institutions that are offering these ESG funds, as it will restore credibility and drive more customers and investors to their asset management firms.  

But to prepare for a more-regulated future and drive trust in their green products, US financial institutions need to go a step further. Looking to industry standards can help firms ensure that sustainability is properly represented in their financial products and risk functions. 

Incorporating insights from the EU Taxonomy as well as other regulatory developments and standards like the International Sustainability Standards Board or Sustainability Accounting Standards Board, can help financial institutions here in the US to refine their regional sustainable finance policies to ensure their strategies, risk functions, and financial products are genuinely aligned to ESG standards.    

At Baringa we're supporting clients to develop sustainable finance and ESG strategies. Based on our experience in this space, there are three initial steps that firms can take to facilitate sustainable investment and prevent greenwashing: 

  • Define the internal sustainability-related objectives of your financing activities and begin monitoring your transactions’ alignment with these objectives.  
    The objective of sustainability financial products is typically to allocate the proceeds to green and/or social projects. Green financial products typically support the transition to a net zero economy through technology financing or climate mitigation. Firms can monitor alignment with product objectives by tracking project proceeds, engaging with stakeholders, and assessing project impact. 

  • Seek to align projects/transactions that you internally deem sustainable with internationally recognized standards to improve comparability and credibility.  
    For example, aligning sustainability bond products to the Green Bond Principles illustrates your commitment to transparency and the goals of the Paris Agreement. These external initiatives have developed credible standards and guidelines based on the latest climate science. Participating in these initiatives not only demonstrates alignment with this science, but allows for comparability among green product offerings. 

  • Conduct an Environmental and Social Impact Assessment of projects/transactions and define an internal policy that seeks to minimize environmental or social harm identified through this Assessment.  
    Typically, firms first implement enhanced due diligence for project finance activities. However, it is best practice to undergo impact assessment of all financial transactions. Aligning to an international framework, such as the Equator Principles, illustrates sound risk management and due diligence processes. This is common practice for most large global financial institutions, and can serve as a starting part for developing a more tailored process specific to your business and its operations. 

No longer is there the open-ended question, “What will the SEC do?” The time for action has arrived. 

While the proposals are still in the public comment stage, US financial services firms now have better guidance around how the SEC plans to enforce ESG investments.  No longer is there the open-ended question “What will the SEC do?” that allowed for time to ponder approaches and need for regulation.  Companies and lenders now have a clear directive to be more transparent about their sustainable finance projects, transactions; the goals they look to achieve, how they measure those achievements and the plan to get there.  

As the SEC’s decision to begin fining US firms demonstrates, there is no time to wait. Financial institutions should assess their internal climate-related disclosure guidelines and ESG investment practices to ensure that they withstand greenwashing scrutiny and actively drive real change.  

Baringa’s team of ESG and climate experts can help you get started on portfolio analysis and ensuring your investment policies and disclosures adhere to the proposed guidelines. Contact Hortense Viard-Guerin and Melissa Klim for support in this space.  

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