New EU 'green-washing' rules will force automakers to be transparent

Up until now, the pressure on companies to do good has largely come from a sense of ethical or moral obligation. But a new green initiative from the EU is raising the stakes by tying environmental, human rights and governance standards to access to capital and risk management. 

The initiative, called the Sustainable Finance Framework, is forcing companies to be transparent about how well they are complying to those standards. It applies to big institutional investors (funds and asset managers, for example) and the companies (automakers, for example) that they invest in.

By forcing transparency, the rules also seek to cut down on “green washing,”  the practice of claiming that a product is environmentally friendly, often on scant evidence, to burnish your corporate image. A growing number of lawsuits, especially in the U.S., are taking companies to task for such claims, and experts say courts are taking a more favorable view of them.

Ruth Knox, a managing associate at the British law firm Linklaters, described the regulations, expected to be finalized at the end of this year, a “very dark green standard” that aims to “define ‘sustainability’ once and for all.”

What this means for automakers:

Starting in March 2021, institutional investors will have to explain how they take ESG (environmental, social and governance) factors into account in their decision-making -- so they will be asking automakers tough questions about how exactly they are lowering their corporate carbon footprint, or if all their parts are made in countries with strong human rights protections, for example.

“The asset managers that provide financing to car companies are going to start asking very detailed questions about their emissions,” Knox said Tuesday at a Financial Times online event on new legal challenges facing the auto industry. That includes emissions from the vehicles they make, their own production and energy consumption, and even their suppliers.

Car companies will have to consider what effect a bad compliance rating from asset managers will have on their access to capital and financing. “It’s almost a ‘soft stick,’ ” Knox said, “in that automakers will need to look at their competitors and see if they have a better ESG story to tell.” 

In other words, peer pressure.

Starting in January 2022, automakers will have to say exactly what percentage of their operating and capital expenditures align with the EU’s climate goals. They will have to show that their activities make a “substantial contribution” to mitigating climate change for their investments to be classified as “sustainable” by the EU. 

That includes detailed information about sales of electrified models.

The new rules will add force to a trend that has been building in recent years, Knox said.

“We were already starting to see institutional investors engage in activism on ESG topics,” she said, adding, “ESG (policies) are being used as a risk management tool rather than an ethical tool, and that’s a key distinction.”

A failure to act  on climate change is now being seen as a financial risk -- for example, from green-washing litigation -- she said “rather than being seen just as something we ought to mitigate because it’s a bad thing.”

The regulations are running into resistance from automakers. The industry’s European lobbying group, ACEA, said such “dark green” requirements could deter investment overall “at the very time when it needs additional funding to transition towards cleaner solutions," a spokesperson told Reuters last month when the proposed rules were published. 

Knox suggested that the opposite might be true. 

“If your equity is part of a low-carbon benchmark, then you will benefit from a halo effect,” and be more attractive to the growing pool of environmentally oriented capital, such as “green bonds” and sustainability-linked loans, she said.

On a fundamental level, she said, automakers are looking at their strategy to transition to a carbon-neutral way of doing business.

“The writing is on the wall,” Knox said. Automaker will have to ask themselves “what steps are we going to have to take to get there as a business, not only to placate our shareholders but also to ensure continued access to finance over time?”