The Role of Financial Institutions to Avert “Green Washing”

“Lack of money is the root of all evil” – George Bernard Shaw

The G20 Indonesia 2022: Note on Agenda Priorities by the Sustainable Finance Working Group enunciated three priority topics that it will focus on in the year 2022 for sustainable financial policy making. The note accentuates the crucial role of institutions to increase the proportion of sustainable finance in global financing with regard to transition finance and the credibility of institution commitments. It highlights how the inability to facilitate credible investment opportunities for firms could put climate transition at stake. This is because increased regulations and consumer awareness of sustainability would lead such firms to showcase their products to be environment-friendly even if they are not, a phenomenon often referred to as “Green Washing”. If this goes unsupervised, it will hinder G20 member countries’ net-zero commitments as part of their climate agenda.

From climate negotiation perspective, one often hears of companies and countries lamenting the lack of access to finance or reporting the problem of receiving funds for clean projects.  On the flip side, the financial institutions have been heard saying that bankable projects are not available despite the availability of financial flows and that the risks of financing would outweigh the returns from such projects. Thus, there exists a financing conundrum that everyone should be aware of. More funds that may be required by developing countries for financing their elevated climate ambitions may be hard to come by.

The proverbial murky waters of climate finance are further dirtied by the existence of Green Washing in both India and globally. There are two extreme ends of the spectrum that need to be understood here: at the one end, we have entities that abide by the rules, maintain green standards and add to the objective of clean and sustainable development; on the other, entities who do not abide by the rule, fake their green standards and disrupt nature’s development. Now, provision of finance to the ones who abide by the rule is socially desirable and therefore, identification of the true types of the applicant is crucial. Therefore, it is suggested that India should develop a separate institution with a regulatory mandate to screen out those entities that do not “green wash”. Now, such screenings are not devoid of challenges and involve both time and transaction cost. It should be kept in mind that this may have a negative implication on those who do not “green wash” and abide by the green standards in terms of development. The problem is to decide which damage is larger. The designated institution must design a framework in such a manner that the social cost of delay from screening, that is red tape, does not exceed the negative externality generated by the “green washing companies”. It will be clearer if we think this in terms of Type I and Type II error: Type I error is where everyone gets the good as regulations are less, policies are less stringent and therefore it may lead to the problem of “green wash” like the case of Innocent Drinks or the Keurig, etc.; Type II error is where those who abide by the green standards and deserve the finances, have to go through stringent regulations and oversight to receive those finances. Thus, strategies would depend on which of the following errors is thought of the greater evil.  The designated institution may be given the additional mandate of providing aggregation services for micro-entities like farms, residential and commercial buildings, MSMEs that could be brought together so that a climate project gets the necessary critical mass for successfully soliciting funds.

The G20 Indonesia 2022: Note on Agenda Priorities stresses that the credibility of institutions needs to be improved. The funding agencies could gauge the objective of the enterprise and evaluate the risk-return criteria before disbursing payments. A standardized disclosure norm for listed companies issued by SEBI in 2021, Business Responsibility and Sustainability Reporting (BRSR) entails reporting of companies’ ESG practices to the investors. However, it is not made mandatory for all. Additionally, the self-reporting by companies could not be relied upon completely because these could again lead to the problem of “green wash”.

An Intermediary’s function is to channelize the funds and disburse the services to the enterprises after diligent screening. It acts as a bridge between the investors and the clients (borrowers). However, even these intermediaries have achieved little success to disburse funds to the deserving applicants. The problem of access to financial institutions in India and other emerging economies is widely discussed in literature. Credibility of institutional framework lies mostly in providing capital to the firms. Provision of investment opportunities in developing and emerging economies falls behind than that in the developed economies. Different strategies like green banks, blended finance and others are suggested as strategies to fill this gap. While India’s attempt in establishing a green bank has not been successful, it’s attempt in establishing a blended finance institution has been mixed. This is because intermediaries like green banks (IREDA) are not provided legal sanctions by the Reserve Bank of India. Also, an intermediary like a blended finance institution, with a combination of for-profit and not-for-profit objectives for an institution is difficult in situations where unlike the US law, the NGOs/ the non-commercial enterprises are not allowed to reap benefits from the capital invested. A blended finance institution in India, REVIVE, has tried to address such challenges by introducing different types of innovative finance tools. However, it is difficult to gauge the long-term impact as it is not clear who gets the finance and the impact on the society remains invisible.

Relying on independent certification agencies that give ratings to good projects could be solution that could work. Certification avenues like the CBI (Climate Bonds Initiative) for leveraging sustainable financing is present in India, as also is the CII- Sohrabji Godrej Green Business Centre (GBC) for Green Product certification. This process promises a complete guidance to the manufacturers in the entire supply-chain of production till disposal/recycling on abiding by the green standards. However, implementation of such process entails efficiency from each party involved. It has also been illustrated in literature how such closed-knit processes could get affected at any stage. It could delay the process and create incentives for excessive red tape.

This brings us back to the argument for a single macro institution that manages various funding agencies, certification agencies, and provides project screening and monitoring services under one overarching umbrella. It should be mentioned here that the trade-off between the institutional time for screening and the monitoring plays a huge role in influencing the behavior of the companies in choosing whether to abide by the standards or not. The caveat is that these threshold times and regulations should vary for each product and should be analyzed accordingly. Thus, such a standardized framework could help achieve the G20 standards of clean transition and net-zero commitments.

(Views expressed are the author’s own and don’t necessarily reflect those of ICRIER)