As the sustainable debt market continues to grow, investor fears of companies making exaggerated or misleading environmental claims,  more commonly known as greenwashing, are mounting. Lori Shapiro, Sustainable Finance Associate at S&P Global Ratings, investigates the root causes for these worries – and what can be done to address concerns

The mainstreaming of Environmental, Social and Governance (ESG) practices has had a galvanising impact on how sustainability factors are incorporated into investment decisions, including at the financial instrument level. As a result, the market has continued to expand and sustainable bond issuance – including green, social, sustainability and sustainability-linked bonds – is expected to exceed US$ 1 trillion in 2021.

Naturally, this has led to an exponential rise in the number of green claims made by companies. In turn, the volume of marketing and labelling – together with non-uniform sustainability commitments and reporting – has made it increasingly difficult for stakeholders to identify which claims are reliable and which have been greenwashed.

Inconsistencies fuelling concerns 

A lack of consistency in ESG terminology is a main driver of investor confusion when it comes to identifying which companies or financial instruments conform to desired standards. Indeed, the Journal of Environmental Investing Report 2020 found that there are more than 20 different labels being used for sustainable debt instruments, many of which align with different guidelines and frameworks. The wide scope of labels – and even wider scope of what constitutes a “green” or “social” project – makes navigating the sustainable debt space increasingly complex for investors and reduces comparability across instruments.

In addition, a lack of reliable and comparable ESG metrics and reporting is fuelling greenwashing concerns. The quality and consistency of post-issuance use of proceeds and impact reporting is still highly unstandardised, and is significantly fragmented across issuer types and regions, making it difficult to compare and aggregate performance. Indeed, according to a Climate Bonds Initiative report published in May 2021, between November 2017 and March 2019, only 77% of green bond issuers  published on the allocation of proceeds, while only 59% quantified the environmental impact of the projects financed – fuelling concerns that green bonds may not be being used to finance projects that provide a significant environmental benefit.

Harmonisation will pave the way forward

What can be done to quell investors’ fears of greenwashing? It is becoming clear that entities can no longer simply state their sustainability goals or long-term targets. Stakeholders want to see companies produce detailed transition action plans – backed by data and shorter-term interim targets – that demonstrate strong commitments toward a more sustainable future.

At the helm of this are a number of standards and taxonomies that have recently emerged to help standardise the market and mobilise capital toward sustainable objectives. The International Capital Market Association (ICMA) and the Loan Market Association, for instance, have launched a set of principles to promote standardisation and transparency for use-of-proceeds and the sustainability-linked bond and loan markets. And, while these principles are voluntary, an estimated 97% of use of proceeds and 80% of sustainability-linked bonds issued globally adhered to them in 2020 according to the ICMA – indicating there is a desire among corporates to substantiate their sustainability claims.

Despite current progress being made, there is still considerable fragmentation in regulations and taxonomies that limits comparability across regions. As such, the path to achieving global standardisation is likely to be long and winding, and finding a way to establish global harmonisation will prove particularly challenging.

In time, sustainable finance instruments will become more diverse and nuanced, in part to accommodate the new reality: that each sector, even those that are hard to abate, must play their part in decarbonisation. By providing information to stakeholders and adhering to the evolving regulatory landscape, businesses can help mitigate the material risk of greenwashing, while simultaneously quelling investor concerns. As such, looking ahead, we believe that greater investor demand for more detailed and consistent ESG disclosure will continue to drive improvements in this field and add momentum to the evolution of ESG-focused regulatory disclosure and reporting frameworks.