Germany: BaFin aims to tackle greenwashing with its new Sustainable Finance Strategy

The German Federal Financial Supervisory Authority BaFin has developed a new Sustainable Finance Strategy aimed at supporting the financial sector with the transformation towards a climate-neutral and more sustainable economy. The strategy focuses on five key areas:

• Risk-oriented and practical regulation,
• More reliable data on financial climate risks,
• Appropriate management of environmental financial risks,
• Prevention and combating of greenwashing, and
• Generating and sharing knowledge.

In an interview, BaFin's Chief Executive Director of Strategy, Policy, and Control, Rupert Schaefer, emphasised that BaFin's role is to maintain a stable and operational financial system, rather than directing financial flows or pursuing its own environmental, social, or economic policy goals. In the ESG context this means ensuring amongst others that financial institutions have adequate risk management practices in place to address ESG risks and comply with obligations to provide data related to such risks.

Thus, BaFin also actively contributes to the development of the regulatory frameworks by promoting consistency across different financial market sectors, appropriate proportionality, and practicality in regulation. In its strategy, BaFin for example takes a clear position against the introduction of penalizing and supporting factors with regard to capital requirements as they may lead to non-risk-consistent capital requirements, which could undermine the stability and integrity of the financial system.

Additionally, BaFin seeks to improve the availability and reliability of data on financial climate risks by monitoring how sustainability risks are disclosed by institutions. It acknowledges the importance of comprehensive disclosure requirements at the corporate level, such as the Corporate Sustainability Reporting Directive (CSRD) and the European Sustainability Reporting Standards (ESRS).

As already communicated in its guidance notice on dealing with sustainability risks and the just recently amended Minimum Requirements for Risk Management (MaRisk), BaFin reiterates that is does not consider ESG risks to be a new risk category but rather risk driver with special characteristics and as such part of the already known risk categories, such as credit or market risk. Nevertheless, BaFin is aware of and takes into account the issues and uncertainties specific to environmental financial risks and promotes various methodological approaches and their further development.

To address greenwashing, BaFin monitors compliance with ESG transparency and disclosure requirements, such as the Sustainable Finance Disclosure Regulation (SFDR) and Article 5 to 7 of the Taxonomy Regulation. It also supervises the implementation of requirements regarding sustainability preferences under MiFID II and the Insurance Distribution Directive (IDD). According to BaFin’s president Marc Branson, investors are currently not able to quickly and clearly identify the sustainability of a product. He criticised the large amount of sometimes overly complex information that overwhelms investors and proposed the introduction of three categories: First, investments which are suitable for financing climate-friendly activities but are not yet mature. In this case, professional investors are needed due to the risks involved. Second, "exclusion products" that exclude certain activities or sectors. These would include most of the currently existing sustainable investment products. They have less impact but are also less risky according to Branson. As a third category, he mentioned investment products that involve the finance the transformation and the development from "brown" to "green." He described both, their possible impact and market potential as well as the risk of greenwashing, as high.

Lastly, BaFin states in its strategy that it values open dialogue with stakeholders and experts and participates in the work of European institutions and international bodies. It also engages in bilateral exchanges with other supervisory authorities and has an observer role in the German Government's Sustainable Finance Advisory Council, actively contributing to ESG discussions with the Federal Ministry of Finance and others.