Greenwashing – the illusion of sustainability and how to see through it

Published on April 25, 2025 by Pooja Khandelwal

Greenwashing in ESG refers to the use of false or misleading statements about a company’s environmental, social, or governance practices, often as part of a deceptive marketing strategy. For private equity firms, this poses a material risk, as companies may use terms such as “eco-friendly” and “sustainable” to overstate their commitment to environmental responsibility. Originally coined in 1986 by environmentalist Jay Westerveld, the concept has evolved beyond environmental concerns to include misleading statements about social or governance practices. At the time, Westerveld would criticise hotels requesting guests to reuse towels for the purpose of environmental conservation.

Let us deep-dive into understanding how greenwashing operates, its characteristics and the impact it has on private-markets firms and the environment.

How to curb greenwashing in reporting

Identifying and addressing greenwashing in ESG reporting is crucial to ensure trust and transparency between general partners (GPs) and limited partners (LPs). Here is how this can be achieved:

1. Check for vague terms and slogans using artificial intelligence

While reporting on ESG KPIs, companies should be mindful when making sustainability claims such as “eco-friendly” and “sustainable” and should be able to back them up with proper supporting evidence. For example, AI and natural language processing tools can now be used to analyse news articles, social media posts, etc., to find discrepancies between a company’s commitment and its actual practices.

2. Ensure transparency in reporting

During ESG reporting, companies should ensure transparency, scrutinise sustainability disclosures, implement third-party verification and align with recognised frameworks so private-markets firms can obtain clear and detailed disclosures about ESG performance.

3. Evaluate ESG ratings and certifications

Different ESG rating agencies use different methodologies for ESG scoring. Thus, firms should critically assess ESG ratings, using different methodologies, and should focus on evidence-based evaluations of a company’s performance for future earnings, cashflow and past actions backed up by verifiable evidence.

4. Keep abreast of evolving regulations

Regulatory bodies have been increasing scrutiny of ESG disclosures recently; private equity firms must, therefore, stay up to date with evolving ESG regulations such as the EU’s Sustainable Finance Disclosure Regulation to ensure compliance and mitigate risks. Failure to comply with these regulations would result in significant fines and penalties.

How to avoid greenwashing when investing

The following are measures that private-markets firms can take to avoid allegations of greenwashing in their portfolios:

1. Collect and leverage high-quality data from portfolio companies

Robust ESG data is critical to validating sustainability claims and avoiding misleading disclosures. To ensure this, private-markets firms should set a clear process and structure to be able to support sustainability claims, communicate effectively and measure progress over time.

2. Set clear and well-defined targets for sustainability

To proactively communicate key information on sustainability efforts, GPs should work with portfolio companies to set medium- and long-term targets outlining additional steps for progress. Defining measurable targets will strengthen accountability and ensure ESG initiatives are integrated into investment strategy.

3. Strengthen internal policies on ESG integration

To mitigate greenwashing risks and demonstrate effective integration, private equity firms should have clear policies and processes on how they integrate ESG into investment decisions and operations. Private-markets firms should implement firm-wide ESG policies, conduct regular internal audits and establish governance structures to oversee compliance and reporting standards.

4. Assess ESG risks in the portfolio companies' supply chains

A company’s supply chain can negatively affect the reporting company if it is found to be engaging in unsustainable or unethical practices. To proactively manage these risks, private-markets firms should identify potential additional ESG risks and opportunities and conduct due diligence and supplier ESG assessments.

Tool for preventing greenwashing allegations

One such framework that supports the reduction of greenwashing in the context of sustainable investment products is the EU’s Sustainable Finance Disclosure Regulation (SFDR). It contributes in the following ways:

Due to specific disclosure requirements, the SFDR is meant to increase transparency and enable better product comparison, ultimately reducing the risk of greenwashing.
The SFDR helps investors distinguish between funds with genuine sustainability goals and those that may be making unsubstantiated claims by classifying funds as either Article 6 (conventional), Article 8 (light green) or Article 9 (dark green).
It compels asset managers to provide detailed disclosure on how ESG factors are integrated into their investment decisions and the impact of these investments. It requires transparency in marketing material, reducing the risk of exaggerated sustainability claims.
Regulators can penalise companies that fail to comply with the SFDR, discouraging the use of greenwashing as a marketing strategy.

Greenwashing as a potential risk to private-markets firms

Greenwashing poses several risks for private markets and GPs, affecting financial performance, reputation and regulatory compliance. The following is a breakdown of the key risks:

1. Reputational risk

Once exposed, greenwashing may ruin the firm's brand image, eroding investors' trust. Thus, private-markets firms associating with entities that exaggerate or misinterpret their ESG data face reputational damage if claims are exposed. To avoid this, private-markets firms should request detailed documentation of their funds' sustainable practices, enabling investors to make informed decisions.

For example, a Germany-based large-market asset management firm faced greenwashing allegations for making misleading statements about ESG factors being integrated into investment processes, according to the Special Report on Managing Climate Change by the Financial Times. Publicised raids and ongoing investigations have damaged its reputation, leading to increased scrutiny by investors and the public of the firm's commitment.

2. Financial risk

If private-markets firms allocate capital to companies that falsely claim to be adhering to strong ESG practices, it may lead to large financial losses if these companies fail to deliver on their priorities. Hence, investments should ideally be made after thorough research of ESG claims and their validity.

For example, an Australia-based mid-market investment firm with hedge fund strategies and its owner were charged USD145,000 each by the US Securities and Exchange Commission (SEC) for misleading investors about the audit of funds, according to the SEC. It claimed that its funds are independently audited, but they were not. This increased legal costs for the company, leading to significant financial repercussions.

3. Regulatory risk

As ESG regulations such as the EU’s SFDR and the SEC’s climate disclosure rules become stricter, private equity firms must ensure that ESG reporting is accurate and verifiable. Failure to comply would lead to investigations, financial penalties, legal liabilities and enforcement actions by regulatory bodies.

For example, an Australia-based large-market asset management firm was fined USD12.9m for making misleading statements about ESG exclusionary screens, according to the Federal Court of Australia.

How Acuity Knowledge Partners can help

Acuity Knowledge Partners provide clients with ESG research, data validation and regulatory compliance support on a day-to-day basis. This could involve providing sustainability claim analysis, emissions verification and ensuring alignment with global frameworks such as the GRI, SASB, SFDR and TCFD. We also help investors and asset managers evaluate their existing or potential investments for compliance with greenwashing and other ESG practices to provide better disclosures to their clients.

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About the Author

Pooja Khandelwal

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Pooja Khandelwal is a Senior Associate at Acuity Knowledge Partners with over 6 years of experience in ESG assessments, reporting, and data analysis. She specializes in delivering customized ESG and sustainability solutions to clients across global markets. She holds an MBA degree in finance and HR from Banasthali Vidyapith.