The Greenwashing Trap in Finance – Are We Truly Going Green?

As we move further into the 21st century, discussions about sustainability and environmental responsibility have intensified. Consumers, especially millennials and Gen Z, are more aware than ever about how their purchases affect the planet leading to a growing demand for sustainable products and practices. However, this heightened awareness has also given rise to a troubling trend: greenwashing.

Are we making a difference, or are we just painting everything a shade of green?

Greenwashing in the financial sector

In relation to the financial sector, 'greenwashing' is the practice of misrepresenting the extent to which a financial product or investment strategy is environmentally friendly, sustainable or ethical. This practice erodes the gains made through green financing as it misleads investors by exaggerating or fabricating the financial institution’s commitment to ESG (Environmental, Social, and Governance) principles, essentially marketing a product as "green" when it isn't, to attract investors seeking ethical options.

There is an ambitious agenda to shift economies to a more sustainable state. The financial sector has a critical role to play in financing this transition. Given the speed of the transition, more and more firms are making claims about moving to net zero, being green or offering green products.

As the urgency to meet climate targets increases, so does the need for real, measurable impact. It’s no longer enough to say our portfolios are 90% green, we need to understand what those numbers really mean for our planet and sustainability.

Consequences of greenwashing in the financial sector

A financial institution that claims to be sustainable but is perceived to have misled customers will face widespread negative market publicity, causing significant damage to its reputation and loss of market share allowing competitors to gain a competitive edge.

Secondly, customers will lack trust in such institutions causing a reduction of the flow of capital into other genuinely compliant financial products and lastly, such institutions risk facing legal consequences. International regulatory authorities and nongovernmental organizations are increasingly scrutinizing businesses for potential greenwashing. Financial institutions may face significant fines, which can further impact their reputation and profitability.

It is no longer viable to remain silent on sustainability and responsible business standards, this practice known as "greenhushing," is playing down or withholding sustainability information. Financial institutions should not make aspirational statements without a plan on implementation either.

In the recent past, regulatory and legislative priorities have shifted to force disclosure and to highlight businesses that fail to do so.

Case scenarios in regulating greenwashing in the financial sector

1.????? North America: The approach in the US can best be described as regulation by enforcement. This reflects the activity of its regulatory agencies and high levels of litigation, including class actions. Reliance is being placed on existing general-purpose disclosure rules, for example, investment advisers owe a fiduciary duty to their clients to make full and fair disclosure of all material facts; if advisers hold themselves out as adhering to environmental, social and governance principles but fail to do so, US regulators may pursue them, even in the absence of positive disclosure requirements for such matters.

2.????? Asia Pacific: Australian legislation generally prohibits the making of statements that are false or misleading in respect to financial products or services. Additionally, the Corporations Act requires product disclosure statements for financial products (where the product has an investment component) to explain the extent to which labor standards or environmental, social or ethical considerations are considered. Elsewhere in the region, the Monetary Authority of Singapore has implemented specific disclosure and reporting standards, including guidance for sustainable funds to mitigate greenwashing risks. Like other jurisdictions, where a fund name uses terms such as "sustainable" or "green," this must be reflected in the underlying investment portfolio and strategy.

3.????? International efforts: The International Sustainability Standards Board has issued sustainability-related financial disclosures standards known as IFRS S1 and IFRS S2. In place of the recommendations of the Task Force on Climate-Related Disclosures, it is intended that these will provide a global framework in developing the use of sustainability-related financial information, including the accurate assessment of sustainability risks and opportunities. This initiative should reduce the scope for ambiguity and inconsistency in standards, thus reducing the risk of greenwashing allegations.

The case in Kenya

The Central Bank of Kenya (CBK) on 12th April 2024 released the draft Kenya Green Finance Taxonomy (the “KGFT”). The KGFT has been drafted to help stamp out greenwashing.?The KGFT mirrors international best practice to enhance interoperability with international taxonomic structures. Further, the framework is underpinned by Kenya’s own specific strategic environmental and development objectives and policies. The details of the KGFT tool has been discussed at length in our article. Such measures aim to enhance the transparency, comparability, and consistency of sustainability-related disclosures.

The current state and future for the Kenyan financial institutions

Kenya has made positive steps towards stamping out greenwashing and ensuring financial institutions are keeping up with the international standards. Further, evidence of efforts towards greening the financial sector is seen in the participation of all Banks in the country in trainings raising awareness on environmental, social and governance risks and financing within the banking sector.

In January 2020, the first corporate green bond in East and Central Africa of Ksh.4.3 billion was issued by the Acorn Group and listed at the Nairobi Securities Exchange (NSE). The bond was also admitted on the International Securities Market (ISM) segment at the London Stock Exchange (LSE). The proceeds were used to build environmentally friendly housing for university students.

While there have been notable efforts in greening Kenya’s financial system, a lot more needs to be done. Financial institutions can conduct periodical audits on their portfolios to track greening progress, further, disclosure of environmental information and environmental performance should be included in the annual financial reports, these are some of the efforts that can be applied to achieve a greener financial future.