“Greenwashing” in the Financial Industry

In the next few years, "green" or ESG investments will become increasingly common in Indonesia. It is time for Indonesian legal authorities to prepare ways to prevent greenwashing practices, especially in the financial industry.

The following article was translated using both Microsoft Azure Open AI and Google Translation AI. The original article can be found in "Greenwashing” di Industri Keuangan

HERYUNANTO

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Awareness about climate change and the need for social responsibility is increasing. This is no exception in the financial industry. Many investors are now interested in "green" investments or those that comply with environmental, social and governance standards, also known as ESG.

Unfortunately, this trend has also given rise to the phenomenon greenwashing, namely the phenomenon when a financial product is marketed as environmentally friendly or socially responsible even though in reality this is not the case. In its latest report for 2023, the European Banking Authority stated that cases ofgreenwashinghave increased sixfold compared to ten years ago.

Exaggerated claims about the "green" nature of a financial product or company not only mislead investors but also have broad impacts on the economy and the environment.

The main disadvantage of greenwashing is the diversion of funds from projects that truly contribute to the environment. This will clearly slow down our collective efforts to fight the negative impacts of climate change such as air pollution and global warming.

However, currently ESG-themed projects are being aggressively pursued by governments and private institutions in various parts of the world. All of it requires a significant amount of cost.

Another disadvantage of greenwashing is the loss of trust of market participants. If investments purported to be “green” or “ethical” turn out not to be as advertised, public trust in ESG financing schemes will be damaged.

This could result in reluctance to invest in ESG financial products, making it increasingly difficult to achieve the noble goals of sustainable development. Humans will increasingly be trapped in poor environmental or social conditions.

Unfortunately, this trend has also given rise to the phenomenon of greenwashing, namely a phenomenon when a financial product is marketed as environmentally friendly or socially responsible even though in reality this is not the case.

Legal consequences

It turns out that the practice of greenwashing also has serious legal consequences, as has recently happened to a number of financial institutions. They were proven to have misrepresented the company's commitment to ESG or the status of the ESG financial products they sold.

Last year in England, HSBC was ordered to withdraw their advertisement that mentioned the company's plan to plant two million trees to help reduce toxic gas. The HSBC advertisement also mentioned a plan to distribute trillions of rupiah in "green" credit.

HSBC is not actually lying, but regulators believe that HSBC is concealing important and relevant information. What was not disclosed is that HSBC still and will continue to provide credit to environmental destructive companies such as oil and coal mining companies.

In July 2023, Vanguard Investment had to go to court in Australia because it was judged to have made excessive claims about one of its ESG financial products. The Australian financial authority, ASICS, discovered that one of Vanguard's index funds which claimed to be "green" still contained environmentally polluting issuers.

In Germany, an asset management company called DWS is facing complicated legal problems. One of the company's own employees leaked to the public that their financial reports contained false statements (misleading) about ESG assets.

This case later became sensational because it implicated the main owner of the company, namely Deutsche Bank. Photos and news spread widely when German police raided DWS and Deutsche Bank offices to collect evidence. Financial authorities from the United States and Germany also intervened to conduct investigations.

DWS is currently awaiting an official "punishment", but has already estimated that they will be found guilty. Therefore, in July 2023, DWS admits to allocating a budget for compensation in the amount of tens of millions of euros.

Conditions in Indonesia

The Financial Services Authority or OJK as the relevant authority in Indonesia has required financial services institutions and public companies to regularly publish sustainability reports. OJK has also detailed what information needs to be reported, including the amount of emissions and waste produced during the reporting year.

However, the concept of greenwashing is still absent in Indonesian legal system. There is no regulation that can specifically define, prevent, and punish such practice, especially in the financial industry.

The practice of greenwashing is actually an implication of asymmetric information which is a natural phenomenon in financial transactions. This happens when the seller has complete information about a product or project, but does not fully convey it to potential buyers.

What is not disclosed is that HSBC still and will continue to provide credit to environmental destructive companies such as oil and coal mining companies.

The literature has documented various adverse impacts ofasymmetric informationwhich essentially causes financial transactions to become inefficient. The most acute impact is the stagnation of transactions so that the financial market completely fails to carry out its function as a channel of funds.

Therefore, it is time for Indonesian legal authorities to prepare ways to prevent greenwashing practices, especially in the financial industry. In the next few years, ESG projects will become increasingly common in Indonesia.

This needs to be supported by an efficient financial market. Starting with the presence of symmetric information between sellers and buyers of ESG financial products.

Nurkholisoh Ibnu Aman PhD Finance Candidate, University of Edinburgh Business School