Mind the splashback: greenwashing and greywashing in sustainability-linked financing

With an ever-increasing stakeholder focus on environmental, social and governance (ESG) outcomes, the corporate world moving to align its objectives with the goal of a net zero carbon economy and an estimated US$1 trillion of sustainable debt expected to be issued this year alone, clear opportunities exist for borrowers and lenders in sustainability-linked financing, both in Australia and internationally.

Accompanying the exponential growth in sustainability-linked financing, however, has been increased scrutiny of the ESG credentials of the parties involved and, in cases where there is a perceived dissonance between reality and the ESG ambitions of the transaction, allegations of ‘greenwashing’ or ‘greywashing’.

_{“If you make net zero claims, you must have substance behind those claims... aspiration on its own is not enough – the bar is set much higher.”}

_{Australian Securities and Investments Commission chair Joseph Longo}^[1]

The Australian Securities and Investments Commission (ASIC) has described greenwashing as ‘the practice of misrepresenting the extent to which a financial product or investment strategy is environmentally friendly, sustainable or ethical’.^[2] Whilst this statement was made in the context of ASIC’s guidance for avoiding greenwashing when offering and promoting superannuation and managed funds’ investment products, it is readily applicable to sustainability-linked finance.

‘Greywashing’ is a closely related concept, which involves the setting of a strategy and policies which appear aligned with ESG principles but which are too unambitious, ambiguous or qualified by exceptions and loopholes to result in meaningful change. 

Allegations of greenwashing and greywashing have been made against both borrowers and lenders, with those involved in financings of mining (including mining services and supply chain), non-renewable energy and transport companies typically being the target of such claims. Transactions can face such allegations for a variety of reasons, with some common themes being:

• a lack of meaningful, transparent and ambitious ESG targets in the parties’ sustainability policies and strategies, as reflected in the documentation of key performance indicators (KPIs) and sustainability performance targets (SPTs);
  
  
• deficient, inaccurate, or worse, misleading or inflated monitoring, measurement and disclosure of borrower’s performance against KPIs and SPTs; or
  
  
• a lack of meaningful consequence (such as an increase in margin, review event or default) where the borrower fails to achieve its KPIs or SPTs. 

‘Washing’ can cost more than reputational damage

The most obvious downside of being involved in a financing that is open to allegations of green or greywashing is reputational damage to the lenders, borrower and advisers involved. This has consequences for the attractiveness of the financial product itself, as well as its integrity and credibility, so much so that earlier this year, the Loan Market Association (LMA), Asia Pacific Loan Market Association (APLMA) and Loan Syndications and Trading Association (LSTA) jointly published Guidance on Sustainability-Linked Loan Principles.^[3]

Increasingly, however, participants in sustainability-linked products (whether borrowers or lenders) need to be conscious of scrutiny from, and potential liability to, regulators, shareholders and other stakeholders arising from how they publicise, comply with and report on their sustainability policy / strategy. For example, a number of jurisdictions have codified the obligations on companies to explain and report on how material ESG risks are factored into strategic and operational considerations, and proposed sustainability financial reporting standards contain similar obligations.

In Australia, ASIC’s recently published Corporate Plan 2022-26 is a clear indication that the regulator is focused on supporting ‘market integrity through proactive supervision and enforcement of governance, transparency and disclosure standards in relation to sustainable finance’.^[4] The plan specifically references greenwashing, with ASIC stating that they ‘will take action to prevent harms arising from greenwashing’.^[5] ASIC have not wasted any time in implementing this, having publicly confirmed they are conducting at least two investigations into potential greenwashing, including one involving a publicly listed company. This reflects a more general trend away from regulatory guidance and towards codification and enforcement.

Alongside regulator intervention, we have also seen an increase in activist groups commencing novel litigation claims against corporates in respect of their ESG commitments alongside allegations of greenwashing. There are Australian examples of shareholders successfully utilising statutory and court processes to gain access to internal documentation of an Australian corporation and, separately, a major financial institution regarding their investment in fossil fuel projects. 

In the case of the corporate, the application was made on the grounds that the company had breached consumer law by misleading investors about its green credentials, and in the case of the financial institution that its participation in fossil fuel projects may contradict its stated policies on commitments to Paris Agreement targets. Such claims will only increase over time, with a logical next step for these proceedings (and other similar recent examples) being the use of the information obtained to launch proceedings, which may include class actions. 

The push towards the standardisation of reporting and disclosure and the focus of regulators like ASIC on upholding the integrity of sustainability-linked finance should result in more robust, consistent data becoming available to demonstrate how well corporates are actually meeting their ESG targets. Likewise, as such sustainability-linked financings start to mature, trends in performance will also become apparent. This may also lead to the inclusion of mechanisms within the financing documentation itself that mandate real consequences (e.g. review event mechanisms, two-way or three-way pricing mechanisms and events of default) for failure to meet SPTs.

Limiting the risks

In the meantime, participants in the sustainability-linked loan market will need to take their own steps to protect their reputations and limit their liability. 

As a starting point, it is important that the borrower should have (or already be in the process of implementing) a sustainability policy and strategy before commencing a sustainability-linked financing process. The policy and strategy should be clear, transparent and verifiable by actual conduct and outcomes, as this will form the basis for the KPIs and SPTs. 

To ensure that the process will withstand scrutiny, the KPIs and SPTs that sit within the financing documentation should be set to ensure that they are:

• relevant and core to ESG factors in the particular borrower’s industry;
  
  
• material;
  
  
• ambitious (i.e. they go beyond ‘business as usual’);
  
  
• future looking;
  
  
• verifiable and result in actual improvements;
  
  
• scientifically sound and appropriately substantiated; and
  
  
• linked to the borrower’s revenue driving model.

Having strong sustainability advisers guiding the borrower and lenders, as well as an independent opinion provider, involved upfront (including, for example, the provision of an opinion as a condition precedent) will also assist, and may provide assurance that, among other things, the financing framework is credible and aligned to market principles. Where red flags are raised, lenders need to conduct additional due diligence informed by relevant subject matter expertise. This should be combined with a requirement for ongoing external verification (which is generally a requirement in sustainability-linked loans) on performance against the SPTs. 

It is also key to ensure that the reporting and disclosure of performance against the SPTs is transparent (and includes details of the underlying methodology used). To the extent possible, it should be made public. The increasing standardisation of sustainability reporting and mandatory disclosure under standards like those of the International Sustainability Standards Board should assist with this.