Tackling the scourge of greenwashing

In February, the world’s first climate lawsuit against a commercial bank was taken out when a group of non-governmental organisations (NGOs) sued BNP Paribas for failing to comply with France’s duty of vigilance law. The lawsuit contends that the bank failed to take sufficient action to end fossil fuel financing.

Observers have not ruled out the possibility of similar legal actions occurring, as NGOs look to hold banks accountable over climate change and sustainability issues. But how can banks ensure that the projects they finance via products such as green bonds and sustainability-linked loans (SLLs) are sustainable and that their clients are not ‘greenwashing’ in order to gain financing?

Amit Puri, global head of sustainable finance at Standard Chartered, describes the sustainability-linked market as nascent. From a bank perspective, the easiest sustainability product to monitor is one where the proceeds of the loan are used to finance a particular project or asset, for example a wind farm, he notes. Clear documentation, ongoing audits and third-party certification help to determine if a particular project is on track. In these cases, the taxonomy of what is green is relatively well understood.

However, when a client borrows for general corporate purposes through a sustainability-linked facility that sets key performance indicators (KPIs) or sustainability performance targets (SPTs), the situation is not as straightforward, Mr Puri says.

“Discounted interest rates or penalties in terms of higher interest rates are applied depending on performance against the KPIs and SPTs. To date, very few – if any – penalties have been imposed, while clients have been able to avail themselves of the interest rate discounts. This has led to questions about whether the targets set were ambitious enough,” he explains. “However, there are only around four years’ worth of these types of loans in the market. I think the situation will change over the next few years as the level of ambition increases.”

SLLs, where the coupon is tied to the delivery or non-delivery of sustainability-related targets, have suffered from a negative press because they are not distinct projects and so they do not offer the “seductive simplicity” that green bonds, for example, offer, says Rory Sullivan, CEO of Chronos Sustainability, a sustainable investment consultancy.

In the case of green bonds, he says: “It is far easier to tell a story and to provide evidence in relation to a project. SLLs, in contrast, can be for any activity whether it is seen as green or not.”

Target setting

Mr Sullivan identifies three key challenges in the SLL space: determining whether sustainability performance goals are sufficiently ambitious, what SLLs are for and how investors know what is being achieved.

On the first challenge, he notes that companies have been criticised for setting “business as usual” targets: those that would have been met anyway or are “easy to do”, and for setting targets that do not reflect the urgency of climate change.

On the question of what SLLs are for, he says a question to be asked is that, if a bank cares about climate change, for example, is it right that an SLL is directed towards activities that improve human rights and wellbeing but could also lead to increases in greenhouse gas emissions? A typical example might be rural electrification, he notes.

Finally, questions can be asked about whether a bank knows what is being done or achieved by the projects it finances. This relates to both the actual outcomes of financed projects and the performance as measured against business as usual.

Banks should play a critical role in overseeing two areas, says Mr Sullivan. First, they should require SLLs to have meaningful, robust targets that ensure the SLL delivers “real outcomes that align with recognised expectations”. Second, banks should monitor performance closely, rather than “rubber-stamping company information”. This requires banks to build up their expertise in monitoring and be willing to act if criteria and commitments are not being met.

However, banks cannot do this on their own, so there needs to be an independent entity that reviews at least a selection of SLLs from each bank, analysing credibility of targets, monitoring processes and so on. “The entire process needs credibility. The virtual absence of examples of companies who do not meet their criteria and/or targets suggests the process is not working as it should,” says Mr Sullivan.

Regulatory push

There is “quite a good track record” in regards to the renewable energy projects asset class, according to Jacomijn Vels, global head of sustainable finance at ING. “These are the projects that typically get the attention of the finance community,” she says. “The more challenging part is other and new(er) technologies that are necessary to work towards a net-zero [carbon emissions] society. These technologies often are at various stages of maturity and need high upfront capital investments that will subsequently be offset by lower operating and/or fuel expenditures.”

If these kinds of projects have to solely rely on financing by the private sector, she says, the pace of the systemic change that is necessary will unlikely be met. “These investments need to be heavily supported by governments and policy-makers,” she adds.

The US Inflation Reduction Act (IRA) and the EU Net-Zero Industry Act (NZIA) will help. The IRA is creating a dynamic in which it becomes attractive for international companies around the globe to move their green investments to the US, she says, while the NZIA seeks to strengthen the support for manufacturing of existing sustainable technologies and looks to support new technologies.

Mr Puri says there are some challenges, largely in the US market, where individual companies are being progressive on sustainability but are challenged by regulators in some states. Overall, however, the level of scrutiny of companies’ sustainability performances has increased, with NGOs and the media highlighting important issues.

Regulation is an important push factor and will create a level playing field for the banking industry and its clients, says Gerrit Sindermann, deputy executive director of the Green Digital Finance Alliance, a non-profit foundation. “The more regulation, industry-driven initiatives and standard setting there is, the more commitment we are likely to see from banks to tackle greenwashing,” he says.

Monitoring the performance of borrowers is “in essence business as usual”, says Ms Vels, so for banks it is not necessarily more difficult to monitor compliance with environmental, social and governance (ESG) KPIs versus credit-related covenants and compliance certificates. What is a challenge, she notes, is the regulatory data or data for the purpose of voluntary disclosure frameworks that are in existence. Because ESG data is necessary for multiple purposes within banks, setting up the right framework is not an easy task.

“There are various initiatives to set up a central ESG data framework and ING encourages such initiatives. Tools for sharing data are nothing new, not even on a global scale; however, if such a tool is designed for use of individual client data by multiple institutions, there is a major challenge to overcome in terms of data privacy protection,” she says.

A positive development is the initiative under the International Financial Reporting Standards Foundation for the International Sustainability Standards Board, which is developing standards that aim to bring a comprehensive global baseline of sustainability disclosures for both investors and the financial markets. The first draft of the standards is expected to be published during the second quarter of 2023.

Training and expertise

Sandrine Enguehard, global head of positive impact solutions at Société Générale, highlights another challenge for banks: internal staff. “The very first challenge we’ve experienced in previous years was people: onboarding people into the bank’s sustainability journey and training them on the environmental and social issues their clients are facing,” she says.

Identifying sustainable projects requires strong expertise in the identification of environmental and social (E&S) risks, evaluation and impact assessment, and monitoring, especially in sensitive sectors and emerging industries. Around 40,000 Société Générale staff received E&S training in 2021, Ms Enguehard notes.

Yet another challenge, adds Ms Enguehard, is to define what constitutes a sustainable financing and to make the criteria as objective as possible. “We need to cope with different stakeholders having varying definitions of what a sustainable project means in a market that is evolving fast. Hence, what is key for us is to rely on existing best market practices and recognised standards,” she says.

This includes using the EU Taxonomy “as a compass in the determination of suitable eligibility criteria for green loans and for social loans, even though the EU Social Taxonomy proposal guidelines are still in development”, she says. These types of loans require a minimum number of projects respecting the eligibility criteria, which might constitute a constraint for some companies, she adds.

A lack of standardisation, data availability, complexity of sustainability issues, greenwashing and uncertainty about future regulatory frameworks are some of the main challenges for banks and investors in identifying sustainable projects, says Ángel Agudo, vice-president of product at sustainability technology provider Clarity AI.

“Focusing on the final challenge, regulations around sustainability are constantly evolving, which can create uncertainty for banks and investors,” says Mr Agudo. “This uncertainty can make it difficult for them to assess the long-term viability of sustainable projects.”

Advanced technologies, such as artificial intelligence and machine learning, can help banks and investors potentially address the challenge of uncertainty around future regulatory frameworks related to sustainability by providing the flexibility to evolve with the regulation and to incorporate predictive analytics, environmental risk assessments, scenario modelling and more accurate ESG ratings, he adds.

Measure and monitor

Data plays a big role, not just in evaluating which projects to finance, but also in the ongoing assessment of whether a project is sustainable, says Steve Round, co-founder of SaaScada, a cloud-based banking platform focused on financial inclusivity. “The challenge for banks in loan origination is that historically they have focused on repayment, rather than the impact of the project being financed. No one has asked whether the project did what it set out to do. Banks are relatively weak when it comes to measuring the real impact of a project,” he says.

Mr Round is also chair of the Global Alliance for Banking on Values, a network of independent banks using finance to deliver sustainable economic, social and environmental development. Member banks measure the impact based on the “real economy”. “One of the challenges of sustainability and avoiding greenwashing is how we as an organisation develop ESG and values-based banking, and how we instigate even more change. The aim is to agitate, innovate, incubate and then go mainstream,” says Mr Round.

There are, however, challenges in becoming sustainable, and Mr Round points out that banks “cannot suddenly turn everything off or stop lending into certain areas”. Better use of technology and data will enable banks to understand their corporate clients more and be able to offer them alternatives, such as carbon footprint offsets. “What a bank does on the lending side specifically is key to fighting climate change and improving sustainability, and we need to incentivise this,” he says. Such incentives could take the form of cheaper loans, for example.

A challenge in incentivising corporates and individuals to achieve sustainability is that often organisations “don’t know how to get there”, says Mr Round. There are almost as many impact investment consultants as products, he adds.

Data availability

Mr Sindermann agrees that data plays an important role, but notes that the reliability of data can vary across borders. “In the past, client advisers could be overwhelmed with all of the traditional finance work they had to do. Now a multitude of dimensions have been added for specialist teams to assess environmental risk, for example. Sending out a questionnaire to clients will no longer be enough,” he says.

As digital technology continues to improve, says Mr Sindermann, better data availability, more integration and service providers will lead to more systematic measurement of the performance of sustainability projects, with data also more easily shared.

Ms Enguehard adds that banks struggle to cope with the lack of standardised E&S impact reporting. “There is a need of harmonisation in impact assessment methodologies, and it takes time and lot of resource for our clients to improve their impact reporting. Even if we observe a real improvement, more transparency is still needed regarding ESG data,” she says.

Data is extremely important, says Mr Puri, and Standard Chartered has created internal infrastructure that is largely driven by regulatory requirements and “gives us a good sense of where our clients are. The biggest data challenge is in carbon emissions in emerging markets where calculations are not made in some countries. We use proxy data based on the country and sector, but there is a tendency to over-allocate emissions to individual clients. As data quality improves, we will be able to make more accurate decisions about individual clients.”