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To fight perceptions of greenwashing we must find a middle ground between burdensome regulations and the Wild West of ESG ratings, argues Victoria Judd of global law firm Pillsbury Winthrop Shaw Pittman.
Recession seems to be the word on everyone’s lips, with the question being ‘when’, not ‘if’.
Though this concern doubtless abounds among banks, the future looks reassuring for green bonds at least. Though we can expect a hit, the number of issuances should still reach the same total amount as last year: some $550bn by the end of 2022. After all, $54bn of green bonds were issued in September 2022 alone, despite already-tightening economic markets.
Such issuances are generally being accompanied by growth in the number of external reviews that validate the ‘green’ characteristics of the bonds being issued, even though there are no mandatory requirements to conduct such reviews.
But even though the future looks green, concerns remain in relation to greenwashing. The broad sentiment is that we still lack reliable and transparent information for investors to conduct sufficient environmental, social and governance (ESG) due diligence.
Just as the question of when a recession might bite is increasingly being asked, so too is the question of whether we need more regulation to tackle greenwashing.
What regulation offers
To date, the Green Bond Principles (GBP) published by the International Capital Market Association have provided the industry with guidance on what qualifies as ‘green’. Their main aspect is that proceeds should be used in a green project, there should be some management of how funds are applied and there should be certain reporting obligations.
In the name of combatting greenwashing, the GBP were followed in 2021 by EU consideration of an EU green bond (EUGB) label that can weed out ‘brown’ companies, or those engaged in environmentally harmful activities, increase transparency and strengthen supervision over green bonds.
To avoid greenwashing, the current proposals suggest that any EUGB label will need to have a verified transition plan to avoid being considered brown, and would be mandatory for all bonds marketed as environmentally sustainable.
While these are well-intended and should help streamline further green investments, the market is reluctant to be subject to more regulation, and so the EUGB label may not be the expected quick fix for greenwashing. After all, the requirement for further compliance could also increase the administrative costs of a green bond issuance, which is already more expensive than a ‘regular’ bond.
It may therefore be that those who benefit from the EUGB label are investors seeking to protect themselves from any whiff of greenwashing, instead of the companies trying to raise finance for their green projects. Such companies could, of course, choose to access traditional debt capital market sources or less regulated markets.
There is a further question as to whether the mechanism for assigning a green label is sufficiently robust once laid out in legislation. The expectation is that perceptions in relation to greenwashing will continue to evolve as we move along the energy transition.
Both the developing EU Taxonomy and any assessment of ‘transition plans’ for alignment by any green bond issuers will evolve in tandem with that transition. This introduces subjectivity and nuance, or at the very least lack of certainty, which will not help give the market the comfort it needs in relation to the EUGB designation and greenwashing.
The ratings alternative
While regulation may impose too many requirements, the alternative is the proliferation of ESG ratings and other data products that can provide a one-stop shop assessment. Market demand for ESG ratings has markedly increased in the past few years, and reports indicate that the annual growth of the ESG data products market is currently at 20%.
However, external or independent ratings are themselves subject to critique. First, there is currently no industry standard: methodologies, topics and weightings vary substantially between rating agencies, which have access to inconsistent disclosure and availability of ESG information from corporates seeking ratings.
Second, reliance on a single rating poses transparency risks as it is unclear how ratings are established and how comparable they may be across different rating agencies. Echoes of good ratings for mortgage-backed securities portfolios resonate as investors refer to a single-letter rating in relation to overall ESG performance.
Perhaps unsurprisingly, as with most emerging sectors, a balance still needs to be found between setting higher regulatory hurdles and oversimplification to allow for market comparisons between companies. As definitions settle and ESG reporting requirements become more standardised, along with investor expectations, the green bond market will certainly follow.
At present, there is no substitute for common sense and due diligence as the best means for avoiding greenwashing claims. In any event, it is not the green qualifications alone that will lead to investment in green bonds, but the strong fundamentals underlying the proposed project.
Victoria Judd is counsel at global law firm Pillsbury Winthrop Shaw Pittman.
