Sustainable finance will play a major role in the climate transition and secured lending, both in the retail and commercial sector, is no exception.

Lenders, who are being encouraged by regulators and the government to innovate in this space, know that the sustainable finance market presents attractive opportunities to will empower customers to meet sustainability goals. In this context, the anti-greenwashing rule is a very loud reminder of the need for careful consideration when designing and marketing these kinds of green lending products, and there are various aspects which firms should consider.

Anti-greenwashing rule

The FCA’s anti-greenwashing rule (ESG 4.3.1 R) applies to all regulated firms, regardless of the product or service they are offering.

When making sustainability-related claims about products and services, firms need to ensure these are consistent with the sustainability characteristics of those products and services and communicated in a way that is fair, clear and not misleading.

Guidance from the FCA says that claims should be correct, clear, complete and use fair comparisons.

It’s important to note that the FCA’s definition of “sustainability” is wider than just the environment/climate and also includes social issues.

These social issues are receiving increasing attention from the media, regulators and governments across the globe. Firms lending to businesses exposed to risks of bribery and corruption, modern slavery or poor employment practices could be at risk if they attribute sustainability characteristics to their products and services without the right measures being put in place.

For example, the Welsh Government has identified the care sector as being high-risk for labour market non-compliance, creating risks for lenders involved in that sector who make associated sustainability claims.

Firms also need to consider the whole lifecycle of a product or service when assessing its sustainability characteristics.  In a lending context, this means ensuring that money loaned is applied in accordance with the lender’s sustainability claims throughout its lifecycle.

Greenwashing risks for sustainable lending

Sustainable lending products are available in both the retail and commercial sector and there is an obvious risk to lenders who attribute sustainability characteristics to such products which cannot be justified. Typically, products will offer incentives to customers to achieve sustainability goals such as improving energy efficiency or reducing carbon emissions.

The most obvious risk arises where misrepresentations are made to a customer regarding the sustainability characteristics of a product or service, but these are less pertinent in a lending scenario. In terms of lending the sustainability characteristics are more likely to rely on the customer’s behaviour as opposed to the lender’s conduct.

However, firms which make representations about the sustainability of their organisation to attract customers could be at risk of greenwashing if those representations cannot be justified.

The FCA’s guidance suggests that claims a firm makes about itself can be caught by the anti-greenwashing rule if they form part of the “representative picture” of a product or service which might influence its audience.

The more pertinent risks with sustainable lending arise from statements made to third parties and are less obvious. Many firms will offer sustainable lending products with a view to achieving sustainability-related objectives of their own and will make commitments and statements to third parties as to the benefits that are being derived from these products.

This creates risks where the relevant sustainability characteristics cannot be evidenced. For example, because a lender is not checking that its borrowers are applying funds loaned towards agreed sustainable objectives.

The risks become greater as:

• Sustainability-related statements provided in annual reports (e.g. climate related disclosures) or in investment prospectus could be viewed as inaccurate
• Sustainability-related commitments to funders could be impacted
• Related claims in adverts or other promotions could be inaccurate
• Perceived greenwashing could lead to reputational damage

Firms relying on sustainable funding lines from capital markets will want to ensure that those funds are loaned to borrowers who apply them in a manner consistent with their obligations to the funder.  Whilst failing to meet such commitments may not breach the anti-greenwashing rule, it risks a dispute with the funder, who will likely have made their own commitments and representations as to the sustainability of their lending.

Firms funding sustainable lending through retail deposits could face double-edged greenwashing risks, if the deposits are generated through products themselves badged as sustainable.

The depositors will expect their funds to be applied consistently with the sustainability characteristics of their product and so a failure in respect of the lending product to meet these objectives could  breach the anti-greenwashing rule both in respect of the deposit and lending products.

Mitigating risk

When offering sustainable-lending products firms should consider then end-to-end lending journey to understand the commitments they need to fulfil and the risks which might impact those commitments.

Where there are risks that the customer’s conduct will impact the lender’s sustainability commitments or statements, this could be mitigated by designing the product in a way which restricts the customer’s ability to apply borrowed funds in the wrong way or gives the lender meaningful recourse where their conduct does not support the desired sustainability objectives.  For more complex products, firms will also wish to ensure that due diligence processes are sufficiently rigorous to enable a good understanding of a customer’s sustainability profile and relevant risks before lending is advanced.

Lenders reliant on partners to meet sustainability objectives will want to ensure they have appropriate monitoring in place to ensure funds are being applied as expected.  Where lenders work with partners, for example contractors carrying out green home-improvements, their terms of engagement should include audit and monitoring provisions.

By ensuring a full understanding of the product lifecycle lenders can identify risks to their sustainability objectives.  Having identified those risks, lenders can tailor sustainability related statements and commitments with a view to mitigating greenwashing risk.

Tom Black is partner at Eversheds Sutherland