There is no question that greenwashing is becoming an increasing compliance and reputational risk for financial firms. It has been a major focus of ASIC’s recent public commentary, including speeches and its Report 763 on greenwashing interventions. Defined by ASIC as: ‘the practice of misrepresenting the extent to which a financial product or investment strategy is environmentally friendly, sustainable or ethical’, the report details 35 greenwashing interventions ASIC has made, including corrective disclosure and infringement notices.
The Government more broadly has been focused on mandatory climate disclosure, and the sustainable finance framework, with a second round of consultation recently closing. The May Budget provided further funding for sustainable finance, including funding for ASIC to address greenwashing. In addition, the Senate will report at the end of 2023 on greenwashing, including considering legislative options to protect consumers.
In addition to the various infringement notices, ASIC has been very active in the past six months, launching three Federal Court actions alleging greenwashing related misleading conduct and/or false or misleading representations in breach of the ASIC Act. In this article, we take a deeper look into some of the considerations and questions firms should be asking to better understand this nascent regulatory and reputational risk.
A closer look at greenwashing
With all eyes on greenwashing, it is worthwhile taking a closer look at the details of the three court actions ASIC has initiated, to help other firms understand and address greenwashing risks before they too raise the ire of the corporate regulator.
Court action consumes both human and financial resources, can cause reputational damage and can be a distraction from strategic goals. ASIC is seeking civil penalties in these cases, which can amount to millions of dollars. In addition to legal and compliance considerations, it is critical to consider risk culture and decision-making processes and how they influence outcomes especially as the external environment and priorities shift.
The Mercer action
In February this year, ASIC launched its first action in the Federal Court to address greenwashing. According to ASIC’s originating process and concise statement, Mercer offered several investment options (‘Sustainable plus’ investments), which, according to its marketing material, excluded investments in certain sectors, particularly: alcohol production, gambling and carbon intensive fossil fuels. ASIC alleges that, in fact, various ‘Sustainable plus’ options included investments in these sectors, listing those holdings in detail in its submission to the court.
The Vanguard action
In July, ASIC launched its second action, this time against Vanguard, alleging that Vanguard had marketed and sold an ‘Ethically Conscious’ bond fund, without ensuring that the index it was based on was, in fact, screening out bonds issued by entities in certain industries. Vanguard’s PDSs and marketing material provided that the underlying index the fund was based on excluded companies with significant activities in ‘unsustainable’ industries including fossil fuels. However, according to ASIC’s concise statement, the screening for these companies was only applied to publicly listed companies, and as such, a large percentage of the bonds in the fund were issued by entities that were not screened. The result was that the fund held bonds issued by entities heavily involved in fossil fuel activities, including Chile and Abu Dhabi’s state oil companies and various energy generators. Later PDSs included updated information and noted the limitations of the screening. This action came after ASIC had issued infringement notices to Vanguard with respect to another of its funds, in which a tobacco exclusion was overstated.
The Active Super action
In August, ASIC launched its third action, against Active Super, a fund that specifically marketed itself as a more sustainable/ethical super fund. In this case, again ASIC alleges that the fund’s marketing and disclosure material made representations that it would screen out certain investments, specifically tobacco, gambling, Russian investments, oil tar sands and coal mining, but the fund nevertheless maintained both direct and indirect investments in these industries.
Managing the risks – key focus areas
At the broadest level, risks can arise from both intentional and unintentional conduct. We imagine that few, if any, companies set out to intentionally mislead their customers or other stakeholders which would be a clearly egregious failure. But risk management shortcomings or deficiencies can often precede poor outcomes and there are a number of key areas that warrant attention in light of the focus on greenwashing.
Understanding compliance obligations
Legal obligations can be complex, difficult to understand and accountabilities for compliance spread across an organisation. And as the lead up to the implementation of Prudential Standard CPS 230 Operational Risk Management has shown, these are often not mapped to risks and controls. Across many domains, we often hear that there are differences in internal opinions regarding the interpretation of obligations; it is easy to see how ‘sustainable’ might fit into this category.
As an example, sustainable investment options might have been created with the intention of divesting from the ‘unsustainable’ assets over time, but nevertheless was initially marketed as sustainable. There may be discussions around the term ‘exclude’ – meaning preventing the entrance of new ‘unsustainable’ companies into the investment mix of the sustainable options, but not removing existing investment. Similar discussions could take place around how investments would be screened, with implementation in practice varying from what was expected or assumed.
ASIC’s public statements around greenwashing only really ramped up mid 2022 with the release of Info 271 (although its focus far preceded this, with it appearing in corporate plans as early as FY2020-21, while NGOs and the ACCC were calling out greenwashing much earlier). When compliance expectations start to shift, firms need to be ensure that there is sufficient consideration of how risks and controls may need to evolve or be strengthened – easier said than done!
Effective risks, controls and oversight
We often find that the design and operating effectiveness of controls – as they relate to both risk management and compliance – can be set and forget. It is not a stretch to imagine a scenario where there were good intentions and agreement to divest the ‘unsustainable’ assets, but that it was not implemented in a timely manner by the investment team.
How well do your risk and control frameworks address issues like these in practice:
- ensuring that the actual investments in the relevant investment options are properly managed to ensure they are consistent with the intention of those investment options;
- whether there are any gaps in screening processes, how claims made by providers are interrogated, actual checking of what is held in funds to ensure that it is consistent with the marketing and disclosures;
- how small amounts invested, potentially in ‘unsustainable’ categories, are identified accurately;
- the level of precision expected in sustainable investment representations;
- how timing or other complexities with the sale of certain assets are managed; and
- how incentives influence investment decision-making.
Working in silos makes it difficult to integrate emerging risks in risk management frameworks
At present, ESG-type risks tend to be owned within Legal, Company Secretary and Corporate Affairs functions. Unsurprisingly, the management of these risks is therefore typically not integrated with firms’ risk management frameworks. A failure to make connections between the activities of different teams is a common gap from our perspective, with each team focused on their own specific areas of expertise, and the oversight of that area without necessarily ensuring that the interactions between the work is consistent. Importantly, the sufficiency of oversight of investment management needs to evolve and consider a broader range of factors, including how accountability and risk culture can influence outcomes. Are Risk teams providing assurance over investment management? It’s not enough for the Risk team to ‘leave it to the experts’.
It is not difficult to imagine a scenario wherein somewhere in the process of creating and marketing an investment option, there was a breakdown in communication between marketing and investment teams. Maybe it was in relation to time-frame differences, with an expected divestment progressing more slowly than the marketing team expected, with a failure to update the other teams. Maybe there was a misunderstanding between teams about what was meant by sustainable options, for example, an investment team perhaps considered the options needed to only have a ‘sustainable orientation’ – with a majority of assets not in the excluded sectors. There are a variety of ways a lack of communication between key teams involved in developing and marketing investment options can result in poor outcomes.
Design and distribution obligations (DDO)
In addition to misleading statements and conduct, it is possible that greenwashing activities could also have DDO implications. Do sustainability statements cause the relevant products to be sold to clients or members outside of the target market? Do your TMDs include any sustainability-related claims?
FAR: Reasonable steps
Although this obligation does not yet apply to superannuation funds, in future a greenwashing breach may also fall foul of the Financial Accountability Regime – accountable persons in this case could be those responsible for product design and distribution, or origination. Do the relevant executives take reasonable steps to prevent breaches of the financial services laws? Can they prove it? See our Insights piece on reasonable steps for practical considerations.
ASIC’s court actions should give superannuation and fund administrators pause, but it is not just funds management – ASIC has made it clear that its greenwashing offensive is wide and deep. There is clear guidance available on how to avoid greenwashing, and thereby regulatory action. In our view, there are several areas where firms can best focus attention.
- Risk culture: ensuring that the culture is both understood and corrected, if necessary, to avoid a situation where it is considered appropriate to deliberately mislead, or strategically obfuscate. Ensuring that risk has a strong voice, including in the oversight of investment management risk and control management.
- Governance and accountability: ensuring, in particular, that emerging risks are effectively integrated in the risk management framework and that there are adequate processes and oversight in place to connect the dots between different parts of the business and that there are well documented decision-making processes and specific checks against ASIC’s guidance on sustainability claims.
Rhizome works with firms across the financial sector to design, implement and uplift risk management processes and practices, including effective integration of emerging risks in risk management frameworks. Rhizome’s extensive understanding of leading practices combined with a practical approach that centres around understanding clients’ business models, strategy and capability allow us to right-size risk management in a way that delivers outsized returns. As a result, their ability to leverage risk management is strengthened across all lines of the business and decision-making is faster and more responsive – meaning strategic goals are met faster and more effectively.
Please reach out to us for more information.
This communication provides general information which is current at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Rhizome Advisory Group Pty Ltd shall not be liable for any errors, omissions, defects or misrepresentations in the information or for any loss of damage suffered by persons who use or rely on such information (including for reasons of negligence, negligent misstatement or otherwise).