Greenwashing in the Fund Industry

Sustainability has gained significant traction across various industries, including finance. With growing concerns about the climate crisis and environmental degradation, investors are increasingly seeking opportunities to support companies and funds that align with their values. However, amidst this surge in demand for sustainable investments, a troubling trend has emerged within the fund industry: Greenwashing.

As defined by the European Securities and Market Authorities (ESMA), greenwashing is a practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services. This practice may mislead consumers, investors, or other market participants.

According to the European Fund and Asset Management Association (EFAMA), within the financial sector, greenwashing consists of two components that should apply in combination (i) knowingly misrepresenting sustainability-related practices or features of a product with (ii) the objective or intention to mislead or induce the receiver of the sustainability claim.

The rise of greenwashing in the fund industry poses significant risks to investors and the broader transition to a sustainable economy. One of the primary concerns is the potential for investors to be misled or misinformed about the true environmental impact of their investments. By allocating capital to funds that engage in greenwashing, investors may inadvertently support companies or industries that harm the environment, rather than contribute to positive change.

Greenwashing undermines the credibility and effectiveness of sustainable investing initiatives. As investors become increasingly disillusioned with greenwashed funds, there is a risk of eroding trust in the entire sustainable finance sector. A Eurobarometer survey conducted by the European Insurance and Occupational Pensions Authority (EIOPA) shows that within the European Union, 63% of consumers do not trust sustainability claims made by providers.

Regulatory bodies worldwide have taken significant steps to combat greenwashing. The EU’s Sustainable Finance Disclosures Regulation (SFDR), implemented two years ago, mandates market participants to substantiate the sustainability claims of their financial products. Similarly, in September 2023, the United States Securities and Exchange Commission (SEC) introduced a new rule mandating funds to align their investments with their stated names. Following suit, in November 2023, the UK’s Financial Conduct Authority (FCA) solidified a new framework governing the usage of terms such as “green,” “sustainable,” and “ESG.” These regulatory measures aim to foster transparency and integrity in environmental, social, and governance (ESG) investing, deterring deceptive practices and ensuring investors can make informed decisions with confidence.

As stated by the Cyprus Securities and Exchange Commission (CySEC) the risks of mislabeling, misrepresenting, and mis-selling are considered to be particularly relevant to sustainable finance. Such risks are encapsulated in the term Greenwashing.

Currently, Cyprus lacks a specific legal framework targeting greenwashing. However, Article 24 of MiFID states that all information, including marketing communications, addressed by the investment firm to clients or potential clients shall be fair, clear, and not misleading.

One should take note of the anticipated EU legislative changes set to occur in 2024. The European Parliament approved the Directive on Empowering Consumers for the Green Transition (DECGT) on 17 January 2024, which aims to combat greenwashing and misleading product information. Upon approval by the European Council, member states will have twenty-four months to incorporate it into national law, likely taking effect around mid-2026.

The Green Claims Directive, which will enforce the DECGT and provide measures for breaches, is set for a committee vote in mid-February 2024. If approved, it could become law before June 2024.

Combating greenwashing and ensuring investors can confidently support genuinely sustainable initiatives is essential for driving positive change for our planet and future generations.