What is Greenwashing: Understanding the Grey Zone and its Risks for Companies

In an era where ESG is increasingly shaping corporate reputation, companies are seeking ways to communicate on their sustainability efforts. However, sustainability claims from companies are increasingly being scrutinised under the ill-defined trend concept of “greenwashing”.

This concern also extends to the financial ecosystem. Sustainability-related information and ratings published by investors and banks are particularly exposed to greenwashing claims, increasing the need for vigilance.

In this introductory article, we will explore the multifaceted nature of greenwashing, examining its various forms and explain why companies should take this concept seriously and take measures to anticipate potential issues.

Our next article will zoom in on the EU's response to greenwashing. We will explore the newly introduced European Sustainable Reporting Standards (ESRS), aiming at promoting transparency in non-financial reporting and providing companies with an actionable framework to mitigate risks of greenwashing.

What is Greenwashing?

A Grey Term

The term “greenwashing” is used in various industries, yet its meaning lacks consistency, making it difficult for companies to understand.

The EU frameworks on sustainable finance reporting alone provide multiple definitions, which further adds to the confusion. According to the EU Taxonomy, greenwashing refers to

"the practice of gaining an unfair competitive advantage by marking a financial product as environmentally friendly, when in fact basic environmental standards have not been met".

On the other hand, the Corporate Sustainability Reporting Directive (CSRD) takes a broader approach and defines greenwashing as "financial products that unduly claim to be sustainable".

In an effort to clearly define the concept of greenwashing, the three European Supervisory Authorities (ESAs, including the EBA, EIOPA and ESMA) have provided in their recent call on for evidence of greenwashing some guidance outlining the core characteristics that can be attributed to greenwashing.

These characteristics include misleading communications:

• Occurring through the omission of information or providing false information
• At entity, product, or service level
• That are intentional but also unintentional
• At any stage of the cycle of financial products/services or investment value chain
• Arising in specific disclosures required by the EU framework on sustainable finance reporting or as a result of non-compliance with general principles
• Triggered by the entity responsible for sustainability communications or third parties.
• If not addressed, undermining trust in sustainable finance markets and policies, regardless of whether consumers and/or investors harm or unfair competitive advantage has occurred

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Factors Enabling Greenwashing

Several underlying factors contribute to the prevalence of greenwashing.

One key factor is the presence of regulatory shortcomings and a lack of sufficient standardization that play significant roles in enabling greenwashing practices. The absence of mandatory requirements and sufficient standardisation allows for the potential of greenwashing practices to persist without consistent accountability measures.

Moreover, the absence of clear regulations contributes to the problem by providing opportunities for unintentional greenwashing. Without well-defined guidelines, companies may unknowingly engage in practices that mislead consumers about their environmental impact.

Different Types of Greenwashing

The ESAs have identified various ways in which claims made by companies can amount to greenwashing. These claims can range from less severe to more severe forms of deception.

Let's take a look at these various claims:

Selective Disclosure

Selective disclosure happens when a company chooses to share only positive information about its products while intentionally leaving out any negative aspects. For instance, a company might emphasise the positive environmental features of its products but conveniently avoid mentioning any drawbacks or negative impacts. It is like handpicking the good and sweeping the bad under the rug.

Empty Claims

Empty claims occur when companies make exaggerated promises that they cannot actually fulfill. For example, a company may publicly commit to reducing its scope 3 emissions without having a credible plan in place to achieve this goal.

Omission or Lack of Disclosure

Omission or lack of disclosure occurs when relevant information is not disclosed. An advertisement, for instance, may conveniently leave out any mention of a company's financial support for fossil fuel companies.

Vagueness or Ambiguity

Lack of clarity happens when claims are unclear or not specific enough. For example, when a company says something like "we aim to reduce our carbon footprint for a better future" without providing concrete details or clear steps on how they plan to achieve it. This refers to fuzzy statements that sound good but lack the necessary specifics to understand what actions they will take.

Inconsistency across Various Disclosures and Communications

Inconsistency is when a company's marketing materials and regulatory documents contradict each other, it can be a sign of greenwashing. For example, promotional material may say one thing while the disclosure documents say something different.

Incomparability

This arises when companies do not provide fair and meaningful comparisons, thresholds, scenarios, or underlying assumptions, it can also be problematic.

Deception

Suggestive presentation is when companies use misleading visuals, sounds, or ESG-related terminology to create a false impression. For example, a company might promote its products using visually appealing green packaging, even if the product itself is not environmentally friendly.

Irrelevance, Outdated Information, and Outright Lies

These misleading qualities of a sustainability-related claim refer to claims that may sound accurate but are actually irrelevant to the company's actual impact on the environment. For example, a company might make statements that sound positive but have no tangible effect on environmental conservation.

Why is it Important for Companies to Avoid Greenwashing?

Engaging in greenwashing practices is akin to playing with fire in today's business world. Not only does it carry real risks for companies, including damage to their reputation and consumer trust, but it also has the potential to create missed opportunities.

Accountability

In the past, companies had the opportunity to engage outside help, such as rating agencies, to shift the blame for greenwashing. But things have changed with the new EU framework on sustainable finance reporting. Companies are now obligated to take full responsibility rather than deflecting it, leaving individuals in leadership positions, particularly heads of legal, unable to evade their duties any longer.

Sanction and litigation

National supervisors bear the responsibility of taking action and addressing these allegations, and the necessary means to do so are already in place.. Presently, national authorities are adopting a proactive approach by monitoring and assessing companies' assertions and imposing penalties for regulatory violations. Moreover, companies are encountering a growing risk of litigation from conscientious consumers and advocates, as the number of climate change-related legal cases continues to rise steadily in recent years.

Reputational risks

Companies must recognize the substantial reputational risk posed by greenwashing. Even the mere accusations or suspicions of greenwashing can significantly damage a company's reputation. Consumer tolerance towards greenwashing has significantly diminished, and the speed at which information spreads on social media, coupled with the consumer's ability to boycott a brand, exposes companies to substantial risks if they make claims that lack genuine actions. The potential repercussions and erosion of customer trust can have enduring effects, affecting the company's reputation.

Shareholder activism

Shareholders are exerting growing pressure on companies to enhance transparency as they have observed the significant impact that ESG factors can have on investment returns. Consequently, company boards must be well-prepared to address instances where shareholders actively express concerns, including those related to greenwashing. Shareholders may even exercise their voting power by opposing specific resolutions during general meetings. Insightia, an organization specialized in shareholder activism and corporate governance, foresees that this shareholder pressure will increase in the future.

Missed thought-leadership

Being transparent as a company not only helps secure financing opportunities but also allows a company to become a thought leader in a market that values environmental, social, and governance factors. Nowadays, investors are paying more attention to these aspects when deciding where to invest their money. When you are transparent about your performance in these areas, it not only attracts investors but also positions your company as a trustworthy and attractive choice. This can lead to greater opportunities for financing and establishing your company as a leader in your industry.

The EU's Response to Greenwashing

The concept of greenwashing still lacks specific guidelines, leaving room for interpretation regarding which ESG claims are considered appropriate. As a result, companies need to undertake thorough evaluation, management, and documentation of the identified risks associated with greenwashing.

In our next article, we focus on how the EU has introduced the new European Sustainable Reporting Standards (“ESRS”), aimed at promoting transparency, to address greenwashing. A welcomed remedy for companies to effectively mitigate the risks of greenwashing.  

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