6 minute read 30 Nov 2022
Energielabel

How can financial institutes avoid greenwashing in the advisory process?

Authors
Stephan Geiger

Head Sustainable Finance for Financial Services | Switzerland

Responsible for building the Sustainable Finance team in Switzerland. Trusted advisor in regulatory transformation and governance projects. Passionate about family, sports, mountains and the ocean.

Heidi Gysi

Senior Manager, Law in Financial Services | Switzerland

Solution-oriented legal business advisor with sustainability at the heart. Advocate of a healthy portion of holistic pragmatism. Not letting perfect be the enemy of good.

6 minute read 30 Nov 2022

Part 2: 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
  • Within the advisory process, greenwashing risks can be expressed as a mismatch between the clients’ sustainability preferences and the sustainability-related characteristics of a financial service or product.
  • The current regulatory environment addressing greenwashing at the point-of-sale rather adds complexity than provides clarity.
  • Lacking ESG literacy on client and client advisor side are also causing greenwashing risks.

What does sustainability mean to you personally? Take a moment to reflect. Your answer may be fairly straightforward – boycotting companies using child labour, for example – or more elaborate – tangible contribution towards the reduction of poverty and improvement of labour conditions of all those in rural communities. Your preferences are likely to mirror your level of sustainability literacy. Two things are certain: There will be as many different answers as there are readers and – more importantly – there is no “right” or “wrong” answer.

Imagine working as a relationship manager at an investment firm or insurer and asking your clients about their sustainability preferences and the array of answers you will receive. Then imagine trying to find investment solutions that match your clients’ objectives. The vaguer the clients express their wishes, the more challenging it will be for the relationship manager to translate those wishes into a suitable investment. And the more limited the relationship manager’s own sustainability knowledge is, the more difficult it will be for the relationship manager to help the clients understand the possibilities and limits of sustainable investments. The risk of greenwashing becomes apparent if it is not managed in a consistent way within the organization.

The risk of greenwashing

The resulting greenwashing risk for financial institutes is obvious: the corresponding risk can materialise as litigation and damages from a civil law perspective as well as reputational damage and dissatisfied clients. Within the financial institutes, the risk that clients are misled about the sustainable characteristics of a financial service or product can occur during any phase of the client value chain. Some institutes struggle with translating the technical language of the regulator into narratives easily understandable by the client. Others consider the biggest greenwashing risk to be the sustainability (il)literacy of their own client-facing staff. A further risk is constituted by the different standards locally, regionally, and globally: a service or product deemed “sustainable” in terms of Swiss standards may not qualify as such on the other side of the borders. In addition, for EU financial institutes, the regulatory aspect needs to be considered.

Forerunner regulation in the EU

In the EU, the amendments to the Markets in Financial Instruments Directive (MiFID II) and the Insurance Distribution Directive (IDD) aim to tackle greenwashing. These two initiatives integrating sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms, respectively insurers, have applied since 2 August 2022. In practice, investment firms and insurers need to identify their clients’ sustainability preferences and ensure that any sustainability preferences expressed by their clients are reflected alongside the clients’ financial objectives in the provision of investment advisory and portfolio management services. To this end, the term “sustainability preferences” is defined by reference to technicalities in related EU sustainability initiatives, such as the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation. If you, as a financial market professional, have a hard time following all the developments, imagine how overwhelmed a sustainability illiterate client must feel.

Diverging standards on sustainability increase the risk of greenwashing.

On 20 July 2022, the European Insurance and Occupational Pensions Authority (EIOPA) published its guidance on integrating the customer’s sustainability preferences in the suitability assessment under the IDD. On 23 September 2022, almost two months after the new regulatory framework had already entered into application, the European Securities and Markets Authority (ESMA) finally published its guidelines on certain aspects of the MiFID II suitability requirements. In particular, both attempt to break down the complexity of the definition of the newly introduced term “sustainability preferences”. For this purpose, they set out in abstract terms that insurers and investment firms need to help their clients understand the concept of sustainability preferences and explain the difference between products with and without sustainability features in a clear manner and avoiding technical language prior to collecting information from their clients on the extent of their sustainability preferences. Furthermore, they set out how an insurer or investment firm must proceed if they cannot meet their clients’ sustainability preferences. Spoiler alert: Unless the clients (temporarily) adapt their sustainability preferences, the insurers and investment firms must not provide the service at hand. It goes without saying that proper documentation is key.

Whereas the EIOPA guidance is non-binding, the ESMA guidelines will apply six months after the date of the publication on ESMA’s website in all EU official languages (The publication of the translations is still to follow).

Laggard initiatives in Switzerland

In Switzerland, there is no federal regulation addressing greenwashing at the point of sale. Interestingly enough, the corresponding duty for financial institutes to consider the clients’ sustainability preferences during the suitability assessment was dropped during the parliamentary debate of the Financial Services Act (FinSA).

In its Guidance 05/2021 on preventing and combating greenwashing published on 3 November 2021, FINMA raises awareness of potential greenwashing risks in the advisory process and at the point of sale. However, with regard to regulatory powers, FINMA’s hands are currently tied. It is, therefore, no wonder that FINMA welcomes initiatives by self-regulatory bodies.

On 28 June 2022, the Swiss Bankers Association (SBA) published its guidelines for financial service providers on the integration of ESG preferences and ESG risks into investment advice and portfolio management. Due to the lack of FINMA’s regulatory powers, for the time being, the guidelines cannot be recognized as a minimum standard. That being said, the compulsory self-regulation is binding on SBA members and will come into force on 1 January 2023, with various transition periods granted for adapting internal bank processes. Non-members are free to adopt the guidelines on a voluntary basis.

A side-by-side comparison of the Swiss principle-based self-regulation with the binding EU standards evidences a handful of significant differences. For instance, the SBA guidelines lack the ambition of aiming at the reorientation of capital flows towards sustainable investments and focus instead on avoiding greenwashing. Another difference is manifested in the focal point of the guidelines: the inclusion of the client’s sustainability preferences into the suitability assessment. In comparison to the EU, the Swiss definition – or rather description – is significantly more lenient in its formulation. In particular, no measurability whatsoever is required and, thus, leaves a greater margin of flexibility for financial service providers. As a result, rather than proactively posing questions to collect information on the clients’ sustainability preferences to enable a measurable evaluation, pursuant to the Swiss standards, a rather general conversation about available ESG investment solutions seems to suffice. Another example of the generosity of the SBA guidelines in comparison to the EU regulation is the (possible) inapplicability of the entire regime in relation to professional and institutional clients pursuant to FinSA. Such a carve out should be applied with care as it is not apparent why the high-level SBA principles of avoiding greenwashing should not apply to e.g. pension funds and wealthy clients.

Overall, Swiss financial service providers are under no obligation to provide sustainability-related services or consider sustainability-related financial instruments in their service provisions. However, they need to clearly highlight and communicate any given mismatch between an expressed sustainability preference by the client and the actual service or product to be offered to him/her, even though no formal adaptation of the clients’ sustainability preferences is needed.

A week after SBA published its new guidelines, Swiss Sustainable Finance together with EY published a Practitioners’ Guide providing practical insights and recommendations on how sustainability preferences of clients can best be integrated in advisory processes. In particular, the guide details the vague definition of the term “sustainability preferences” in the SBA guidelines and suggests various approaches a financial service provider could use if a client shows interest in sustainability. Moreover, the guide mentions different examples of scenarios bearing a certain greenwashing risk, such as the exclusion approaches focusing only on widespread exclusions (“controversial weapons”, “tobacco”, etc.) as well as portfolios that do not include a significant share of investments that are aligned with the sustainable investment strategy, only to name a few.

Dos and don’ts

The question remains: How to avoid greenwashing risks? The proposed efforts to combat greenwashing are similar in all initiatives and focus on informing the client, matching the client’s sustainability preferences, monitoring product compliance, reporting to the client as well as training client-facing staff. The struggle begins with the implementation.

energy label

The "SSF/EY Practitioners’ Guide"

Investors are frequently disappointed when they realise that their individual sustainability goals are not adequately reflected in their investment portfolio.

Download Brochure

Even though there is no one-size-fits-all implementation solution, there are dos and don’ts generally applicable. First and foremost, be prepared to walk the talk – or: avoid raising expectations that cannot be fulfilled. Secondly, foster communication as equals – cut through complexity by using key terms like “sustainable”, “ESG” and “green” in a hands-on and consistent manner. Thirdly, be tangible and pragmatic – what investment solutions may a client showing a high interest in sustainability expect? A portfolio containing 5 % Taxonomy-aligned investments? Or 8 % or even 10 %?

Summary

To sum it up, nip greenwashing in the bud by being transparent. Invest in proper staff training on sustainability topics in general and on the own sustainability-related offering and implementation efforts in particular. Use a common language clear and understandable to both the clients and the client-facing staff. Those are the enablers for engaging with your clients in a meaningful conversation towards positive contribution.

About this article

Authors
Stephan Geiger

Head Sustainable Finance for Financial Services | Switzerland

Responsible for building the Sustainable Finance team in Switzerland. Trusted advisor in regulatory transformation and governance projects. Passionate about family, sports, mountains and the ocean.

Heidi Gysi

Senior Manager, Law in Financial Services | Switzerland

Solution-oriented legal business advisor with sustainability at the heart. Advocate of a healthy portion of holistic pragmatism. Not letting perfect be the enemy of good.