INSIGHT by the WWF
Last week at the Global Ethical Finance Conference 2023, WWF launched a new tool to help financial supervisors, asset managers and financial institutions evaluate the net-zero transition plans of the companies they are investing in.
Backed by AI technology, the new tool will help investors assess whether companies’ transition plans are robust with science-based targets and a credible pathway to achieve net zero by 2050. Importantly, it will be able to identify whether companies are ‘greenwashing’ investors.
The WWF commissioned project co-produced with the University of Zürich and the University of Oxford, highlights the need to carefully assess the ambition, feasibility and credibility of a company’s net zero climate transition plan from a financial supervisory risk and vulnerability perspective. The Artificial Intelligence (AI) tool that will automate and scale up the analysis of transition plans based on a proposed methodology is currently under development and will be publicly available and follow the structure of the ChatReport tool.
Corporate greenwashing poses a serious threat to financial stability and the transition resilience of companies, investors, and the financial system in the transition to a net zero, nature positive economy. Greenwashing leads to capital misallocation, financially riskier and costlier decarbonisation pathways, undermining the ability of markets to price risks correctly and reward resilience to deal with uncertainties. This in turn, can negatively affect the global economy and private households, and even lead to increasing unemployment risks, such as the recently published climate stress test from the Bank of England (BoE) highlights.
For financial regulation, the credibility of climate transition plans is of particular concern because it directly affects consumer protection (consumers are misguided by false claims). It also has direct implications on micro- and macro-financial stability as greenwashing could undermine the effectiveness of prudential policies. On one side, it enables financial institutions to circumvent regulations, and on the other side, it prevents financial supervisors from identifying vulnerabilities in the financial system.
Aware of this threat, regulators and financial decision makers have recently put the issue of credibility and ambitious, feasible corporate transition plans high on the policy agenda. However, despite an increasing awareness of capital misallocation risks there is no common understanding nor is there a comprehensive methodology to assess and measure whether a company’s transition plan can be considered “credible”. So far, regulatory action undertaken by financial regulators to counter greenwashing and transition plan inconsistencies has been to ask for comparable and transparency disclosure such as product transparency (in prospectus, contracts, half yearly reporting, etc.) and a requirement that the sustainability of a financial product is discussed at the point of sale and thereby customers are sufficiently aware of what they buy.
The tool precisely addresses those gaps. It is designed to be applicable at scale by aid of Artificial Intelligence (AI) tools to help identify transition plan inconsistencies and possible greenwashing. They are considered a first screening tool to “red flag” companies whose transition plans lack ambition, feasibility and credibility. For central banks, investors, policy makers and regulators it offers a data-driven tool to carefully assess the companies’ environmental and climate-related claims and select those companies suspected of greenwashing for more in-depth assessments, analyses, and direct engagement.
“Greenwashing threatens financial stability because market participants are relying on misleading claims to price transition risks. Finance for transition must take a dynamic and forward-looking view, taking into account all sectors, in particular the most climate and environmentally harmful industries. It is therefore of crucial importance to properly assess the credibility and ambition of corporate climate transition plans.”
-Maud Abdelli, lead WWF’s Greening Financial Regulation Initiative (GFRI)
For market conduct authorities, red flag indicators are a useful screening tool to automate the process of identifying potential misleading claims and statements.
Furthermore, it can be used as a tool to assess risk exposure at the micro-prudential level and demand more ambitious transition plans. Financial supervisors are recommended to require financial institutions to publish strategies that indicate how it deals with the risk of inconsistency and greenwashing in its portfolio, or towards specific companies.
Dr Chiara Colesanti Senni, Postdoctoral Researcher at the University of Zürich, Visiting Fellow at the Granthan Research Institute (LSE), Affiliated Researcher at the NLP4SF Programme says: “This red flag indicator framework, using Artificial Intelligence tools, provides a data-driven tool to carefully assess companies’ environmental and climate-related claims, particularly identifying those suspected of greenwashing for more in-depth assessments and direct engagement. It is a vital screening tool to automate the process of identifying potential misleading claims and statements.”
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Dr Julia Bingler, Research Associate Financial Risk Data Analytics and Head of NLP4SF Programme, Oxford Sustainable Finance Group, Smith School of Enterprise and the Environment, University of Oxford, says: “Greenwashing is a source of financial risk. Identifying it is thus a priority in ensuring financial stability. A structured analysis approach to analyse ambition, feasibility and credibility of transition plans is required to solve information asymmetries. Our red flag approach enables artificial intelligence-based analyses, which scales up information extraction and assessment for transition resilient capital allocation.”
WWF will support the University of Zurich and Oxford in pilot testing the red flag indicators framework with a number of companies between September and December 2023. The results will be visualised and published in December 2023 to help financial regulators and financial institutions get a better understanding and overview of the grade of ambition of companies.
*Transition plan: Transition plans explain how a business or other organisation aims to achieve the targets it has set, such as biodiversity goals or net zero emissions by 2050. They explain the actionable steps an organisation will take to achieve these longer-term targets and should include clear interim milestones to work towards. Therefore, transition plans go beyond top-level target setting to provide investors, regulators, policymakers and other stakeholders with information on how exactly an organisation plans to achieve these goals.
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