How can financial institutes avoid greenwashing in their corporate reporting?

Part 3: The Age of Greenwashing series addresses how to identify and mitigate greenwashing risks from a corporate reporting, asset management as well as advisory perspective.

In brief

• Sustainability reporting is plagued by insufficient data and a lack of standardization and comparability
• Mandatory requirements and voluntary standards have rapidly developed to address this issue
• However, voluntary and mandatory standards may diverge, increasing greenwashing risks

Acompany’s sustainability disclosures are some of the most insightful resources an investor has at its disposal in order to understand how the company’s performance and growth potential are impacted by sustainability risks and opportunities. Therefore, it is crucially important that financial market participants have access to ESG information that is accurate, reliable and comparable. There is currently a gap in the reporting of sustainability information due to insufficient data availability, inconsistent application within the market, as well as a lack of standardization (and consequently, comparability). Reporting standards are intended to fill this gap and there have been significant developments in this regard. However, this has also resulted in an alphabet soup of standards and frameworks, mandatory and voluntary, general to specific – GRI, ISSB, CSRD, TCFD and the list goes on. While ambitious public commitments are important, they also come with greenwashing risks especially given the various diverging standards evolving.

Proliferation of voluntary standards and frameworks

There has been a proliferation of voluntary standards and frameworks in the market that have a tendency to become regulatory standards. The most widely recognized and influential framework in the area of climate reporting is the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). In the financial market sector, the recommendations often form the basis for legal and regulatory requirements in many jurisdictions, but also act as a guiding reference for investors seeking to integrate climate risks into asset-allocation and portfolio-management decisions. They also act as the prototype for various global corporate reporting initiatives (e.g., International Sustainability Standards Board (ISSB)) that also seek more metrics based ESG transparency.

In the area of Net Zero commitments, there are also established industry-standards for greenhouse gas (GHG) accounting (e.g., GHG Protocol, Partnership for Carbon Accounting Financials (PCAF)) and Net Zero target setting (e.g., Science Based Targets initiative (SBTi)). This is just to name a few, while there are extensive other sector and topic specific standards. Their common denominator is also to provide more transparency and reduce GHG emissions for the core business models first.

EU strives for global ESG data transparency leadership

The EU Corporate Sustainability Reporting Directive (CSRD), replacing the Non-Financial Reporting Directive (NFRD), came into force on 5 January 2023 and will take effect on a staggered basis. The main changes are:

• the lowering of the applicability threshold (i.e., more companies will be in scope);
• detailed ESG metrics disclosures required for large or listed companies in accordance with the various Level 2 provisions in the European Sustainability Reporting Standards (“ESRS”) currently being developed as well as the EU classification system for economic activities that determines which economic activities are environmentally sustainable based on technical screening criteria (“EU Taxonomy”); and
• new independent auditing (starting with limited assurance) and certification requirements.

Large companies’ first full CSRD report will be due in early 2025 based on the company's 2024 fiscal year environmental performance, with SMEs and international companies needing to comply in later years. In contrast, the EU Taxonomy (eligibility) reporting has already started for entities in scope of the current NFRD regarding climate mitigation and adaptation.

While the CSRD will mainly impact EU companies and set a new gold standard corporate sustainability reporting based on ESG data evidence, it will also eventually directly affect some EU subsidiaries/branches of Swiss companies. In addition, it is worth noting from a Swiss point of view that in-scope EU subsidiaries/branches will in the future also be required to prepare sustainability reports for the third country undertakings at a consolidated level, although there is a possibility for them to be in accordance with standards which are deemed equivalent by the European Commission. As an alternative, the EU subsidiaries/branches can be included in the consolidated management report of the parent undertakings, provided that the parent’s report is compliant with (or equivalent to) the CSRD.

The sustainability reports will be required to be provided in a digital format in order to be able to feed the information into the European Single Access Point (ESAP), once ready. This inclusion in a central open access database is a major step in enhancing ESG transparency and making it available to various stakeholders. This goes along with an increasing global ESG transparency trend independent from regulations. For example, at COP27, Al Gore announced that the Climate TRACE coalition has released a detailed global inventory of GHG emissions to spot heavy emission sites and allow the public to track respective progress. The increased ESG transparency means that corporates will have to deliver measurable proof on sustainability expectations they have set. 

Switzerland also takes steps towards ESG transparency, albeit timid

In Switzerland, statutory sustainability reporting and due diligence rules in an indirect counterproposal to the Responsible Business Initiative (RBI) were introduced for the first time into the Code of Obligations in January 2022, with requirements applicable beginning in fiscal year 2023 and first reports expected in 2024. Like CSRD, the Swiss requirements also cover the full ESG scope from a double materiality perspective. However, from an applicability and requirements standpoint, they are closer to the requirements of the less onerous principle based NFRD. Further, as Switzerland does not have its own taxonomy for sustainable economic activities, the Swiss requirements do not apply such a specific classification system nor mandatory long lists of KPIs like in the CSRD. Lastly, while the Swiss requirements also address select due diligence requirements (i.e., child labour and conflict minerals) similar to the current draft proposal of the EU Corporate Sustainability Due Diligence Directive (CS3D), the EU requirements again set broader and more stringent requirements compared to Switzerland. Given the ESG data transparency gap to EU regulations, Swiss financial institutes are well advised to gather key material ESG data for internal and benchmarking purposes in order to justify their messages in sustainability reports. A lack of quality data may lead to misleading statements and a decrease of their own ESG company rating.

In the specific area of climate risks, the Federal Council has introduced the Ordinance on Climate Disclosures, which specifies the content of the reporting on non-financial issues by requiring reporting on climate-related risks, as well as on the impact of company activities on climate change. It foresees the implementation of the recommendations of the TCFD by large Swiss companies, with reporting beginning in 2025. The proper implementation of the various elements covering strategy and risk management components is in our view the biggest challenge for financial institutes. FINMA has correspondingly amended its Circulars 16/1 and 16/2 (Disclosure – banks/insurers) to require the implementation of the TCFD recommendations in disclosures on climate-related financial risks as a principle-based but mandatory standard for Category 1 and 2 banks and certain insurers. FINMA has also recently published Guidance 03/2022 on its findings and observations from the first disclosures.

Reducing the risk of greenwashing – gold standard disclosures, organization and validation

While the development of regulatory and voluntary standards will certainly help address the issues of insufficient data availability and lack of standardization/comparability, it also comes with an increased risk of greenwashing, whether intentional or inadvertent, in the disclosure of misleading, incorrect or incomplete information. The voluntary application of additional standards or public commitments certainly improve the credibility of an institution’s activities and disclosures. However, this can also act as a double-edged sword since the commitments/standards need to be comprehensively and thoroughly implemented, creating further opportunities for missteps based on diverging standards.