Greenwashing: a Technical Perspective

On 18 October, Chancellor Rishi Sunak published HM Treasury’s roadmap for the UK’s Sustainability Disclosure Requirements (SDR) intended to help investors determine if a firms’ practices are aligned with their own sustainability preferences. The rules will mean the environmental impact of every investment product will need to be established and reported under an agreed labelling system designed to be understood easily by consumers. As to Greenwashing, any sustainability claims made will need to be validated and they will be subject to both regulatory and consumer scrutiny.

New Obligations upon British Firms

Disappointingly, the Chancellor Sunak’s roadmap is almost exclusively focussed on climate change and other environmental issues, and perilously little reference is made of how social and governance matters shall be enhanced.

Asset managers will need to consider how they will incorporate sustainability into their investment strategy, while an increasing number of British firms will be forced to publish rigorous plans for how they will contribute to the UK government’s commitment to achieve net zero carbon emissions by 2050.

The UK Green Taxonomy

The Chancellor’s roadmap also contained more detail on the UK Green Taxonomy which will outline which economic activities are classed as ‘green’. Certain companies and products will be required to report their environmental impact against this taxonomy.

The above moves are in the shadow of Europe’s Sustainable Finance Disclosure Regulation (SFDR), which came into force at the start of 2021. The SFDR already makes stringent sustainability-related demands of advisers, and the UK only avoided having to follow suit because of Brexit.

Sustainability Labelling

In its November 2021 discussion paper DP21/4, the FCA explores Sustainability Disclosure Requirements (SDR) and investment labels, especially because many UK firms are already subject to SFDR in respect of their EU business activities. These businesses have already invested in systems and processes to classify products according to SFDR provisions and the E.U. taxonomy, and the FCA recognises the importance of the UK framework being closely aligned in order to not introduce unnecessary regulatory burdens.

Consumer Attitude to Sustainability

The FCA’s own ‘Financial Lives’ survey (2021) asked consumers of retail investment or pension products a series of ESG-related questions. The survey data shows that:

• 80% of respondents wanted their money to ‘do some good’, while also providing a financial return
• 71% wanted to ‘invest in a way that is protecting the environment’ and
• 71% would not put their money into ‘investments which are unethical’

The pattern is clear, and the FCA’s strategy is indicative of the change coming: companies and consumers are increasingly looking beyond climate change as they consider wider environmental issues, such as nature and biodiversity, as well as social and governance issues, such as diversity and inclusion, the living wage, fair taxation, and supply chains.

Labelling Creates Consumer Confidence

Consumer-facing product-level disclosures could provide standardised information on the product’s key sustainability attributes. This would allow consumers to better understand the sustainability characteristics of the product, compare similar products or the same product over time, and hold the provider to account for sustainability claims made.

Classification and labelling of sustainable financial products have become increasingly common internationally, albeit with differences in terms of policy aims and practical implementation. For example:

• The categorisation of sustainable financial products introduced by SFDR has become a de facto classification and labelling system for sustainability-related investment products: products that do not consider sustainability factors (‘Article 6’ products); products that ‘promote’ sustainability factors (‘Article 8’) and products that have sustainable ‘objectives’ (‘Article 9’). The EU is also developing an EU Ecolabel for retail financial products.
• The French Authorities have introduced a SRI label for ESG funds and a ‘Greenfin’ label for climate-focused funds.
• In August 2021 the German Federal Financial Supervisory Authority (‘BaFin’) consulted on sustainable investment labels.

The Timing

While the above concerns everyone in the financial services industry, it applies also to many UK registered corporates, certain UK listed issuers, asset managers and asset owners such as pension schemes and insurers, as well as investment products. Overall, though, the UK SDR will take until 2023 to reach the regulatory stage.

What Does the Future Hold for SMEs?

That said, many SMEs are facing growing requests for sustainability information – typically from banks that lend them money and large companies that they supply. The transition to a sustainable economy is likely to mean that collecting and sharing sustainability information becomes common business practice for companies of all sizes.

Just as the European Commission have introduced new rules for corporations (while extending the range of those in scope from 10,000 to circa 40,000), we can expect the development of separate, proportionate standards for SMEs.

Supply Chain to Drive UK SME Reporting

SMEs listed on regulated markets could use these simpler standards to meet their legal reporting obligations, while non-listed SMEs could choose to use them on a voluntary basis. However, given the UK’s historic approach to such matters, we can expect the Tier One organisations to exert considerable influence upon Tier Two and Tier 3 organisations in their supply chains.

There’s no doubt that future standards will be carefully adapted to the capacity of SMEs, making it easier for them to report information to banks, large-company clients and other stakeholders. Since this will help SMEs to play a full role in the transition to a sustainable economy, we see no argument that this is the future direction.

ESG Reporting for the UK SME: Act Now!

There has always been a temptation for businesses to procrastinate, but on the topic of the environment, the mood of the both the nation and the government is impatient. Consider the introduction of the General Data Protection Regulation (GDPR) which began to raise its head in 2015 ahead of coming into force in 2018. It was chaotic, not least of all because the regulators didn’t conclude the drafts until the last minute, and it was riddled with ambiguities.

With ESG reporting, the frameworks are in place, the techniques mature, and the processes understood. Unlike the GDPR, though, there is a desperate shortage of professionals able to support organisations in getting started, and it’s only going to become worse.

Another important comparison is to consider that the upheaval caused by the GDPR was a storm in a teacup when comparing the GDPR’s rather minimalist set of rules to the entirety of ESG reporting, encompassing as it does the TCFD, SDR, and the EU NFRD and SFDR.

Every organisation, from SMEs through to corporations, should be prioritising the ESG reporting immediately in order that they are prepared for when the forthcoming regulations start to bite deeper.