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19 May 2023

Carbon offsetting? Prove it.

Regulators are closing in on green claims that may be stalling effective climate action.

by Brett Jacobs, Associate Partner, ESG

Companies relying on carbon offsets to hasten their journeys to carbon neutrality, or to soften consumer perception about unsustainable business habits, may soon be in for a wake-up call. Regulators are getting tougher on greenwashing.

The European Parliament has voted to approve the adoption of proposed rules requiring companies to substantiate and verify their environmental claims and labels, aiming to protect consumers from the risks that green claims are not what they imply.

The new rules set out the European Parliament’s negotiating position with EU member states on the EU Commission’s proposed “Directive on Green Claims”, which was released in March 2023. Even though the UK is no longer a member of the EU, UK companies operating within any EU member states will still be subject to its legislation. The Commission says that the new rules are meant to address a need for unambiguous, verifiable information for consumers, highlighted by its recent study that found that more than half of green claims by companies in the EU were vague or misleading, and 40% were completely unsubstantiated.

For UK-only operators, the UK’s advertising watchdog, the Advertising Standards Authority (ASA), is to begin stricter enforcement later this year around the use of terms such as ‘carbon neutral’, ‘net zero’ and ‘nature positive’ as part of a greenwashing crackdown.

Under the plans, the ASA is more likely to take action against firms that don’t back up claims that the purchase of carbon credits – to achieve so-called ‘carbon offsetting’ – really are effective in neutralising the impacts of their products or services on the climate and/or nature.

The decision follows recent enforcement by the ASA against Lufthansa and Etihad about green claims, where the ASA ruled that consumers were more likely to interpret visual references to environmental aspirations as indications that significant steps to mitigate environmental harm have already been taken.

The UK Competition and Markets Authority (CMA) has also launched a wider review of potentially misleading environmental and sustainable claims across the UK fashion and fast-moving consumer goods sectors. The unequivocal message is that the freedoms of companies to run loosely phrased ‘feel good’ green campaigns, as well as make vague promises and pledges to address their carbon and biodiversity footprints, will increasingly attract the scrutiny of regulators.

Why does this matter?

There are significant regulatory and reputational risks and – ultimately – possible material financial and legal impacts to being complacent or blind to the consequences of corporate greenwashing.

In companies’ defence, many businesses are already embracing the energy transition, aligning with the objectives of the Paris Agreement and starting to tackle the broader degradation of nature and biodiversity from deforestation, plastic and chemical pollution, and various other consequences of human activity. 

The key questions for companies, capital markets and consumers alike are what climate and nature-friendly ambitions, promises and pledges are supportable and investable today?

Climate and nature commitments will increasingly need the appliance of science

Validation is at the heart of current scrutiny by UK and EU lawmakers, to derisk commercial environments such that financial markets and consumers can both trust – but, if necessary, verify – green claims and intentions.

Forthcoming consumer protections and market regulations are likely to put the onus on companies to show their workings. Companies that already understand their carbon and biodiversity footprints, and the purpose and science of carbon offsetting, should have nothing to fear from increased transparency. Indeed, carbon credits can be a persuasive tool to evidence for both investors and consumers that companies can invest beyond the business ecosystem to protect and sustain the natural ecosystems and resources that supply their business models.

Quality of carbon credits

However, there is currently substantial potential risk for companies in miscommunicating the use of carbon credits.

Not only is there risk in investing in low quality credits that do not evidence sequestered carbon with sufficient scientific rigour, the net present value of the carbon credit itself is unlikely to be priced fairly. This will be a problem for the operators of carbon removal projects and the local and indigenous communities who would rely on the fair value of carbon credits as the funding needed to incentivise responsible project stewardship.

This is also likely to generate unintended reputational issues for companies, in terms of a potential misallocation of capital that investors would have expected companies to invest more wisely.

Furthermore, the key claim that companies would want consumers to believe – that carbon offsetting in some way negates today the longer-term environmental harm from the company’s activities, products or services – is fundamentally flawed and undermined by low quality, hard to verify credits, and effectively stalling the otherwise painful but necessary changes that all companies will have to make to shift from linear to circular business models. This is central to regulatory concerns about greenwashing.

Buchanan support

Buchanan is working with clients to ensure that their ESG and sustainability narratives are as robust as their financial ones, by helping them to avoid the potential reputational risks of greenwashing.

We encourage clients to think beyond a compliance-led mindset and explore what carbon offsetting could really prove about their company’s purpose, values and journey on a net zero transition.

Companies are getting better at calculating the carbon footprints of their activities, products and services, and how they intend to mitigate or neutralise them. But time is running short to take meaningful action on climate change and nature loss. Words must not speak louder than actions, or market watchdogs and lawmakers may soon respond with actions of their own.

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