Detecting greenwashing and green-related fraud: leveraging

Introduction

The European Union (EU) is at the forefront of raising societal sustainability and protecting environmental well-being. At the same time, sustainability disclosure frameworks are creating new opportunities for compliance professionals or financial intelligence units, to use publicly disclosed environmental, social, and governance (ESG) data in their investigative activities. In this article we explore the potential for selected key performance indicators (KPIs) from EU sustainability disclosures to flag greenwashing or green-related fraud and develop a backbone of a methodology for such assessments.

The hypothesis underpinning this analysis is that publicly disclosed sustainability KPIs allow to flag potential greenwashing or green-related fraud as well as, for selected scenarios, signalling behaviour for more specific money laundering analysis. Such risk-indicators represent future next steps in compliance and counter-organised crime technologies such as DATACROS III.

This assessment, carried out in the DATACROS III Project, focuses on selected frameworks mandating sustainability-related KPIs within the EU, tested against two scenarios: waste-related fraud and green investments fraud. The future availability of disclosures on the European Single Access Point (ESAP) from 2028-2030 will significantly enhance their utility by providing centralized access to financial and non-financial data^[1].

Key terms and definitions

Greenwashing, specifically in finance, refers to the “risks of misleading sustainability claims occurring and misleading investors in their decisions. Sustainability related claims refer to statements, declarations or communications provided either to comply with disclosure requirements or as part of voluntarily communications (e.g., advertisements)”^[2]. These claims can stem from mandatory disclosures or voluntary communications and may relate to financial instruments like bonds, loans, or shares. For the purpose of this analysis, greenwashing is applied to disclosures concerning green bonds.

Green-related fraud is a broader term encompassing greenwashing, involving the deception of the public regarding the environmental impacts of an entity’s products, services, or operations. This can include environmental crimes, such as those related to waste.

Importantly, money laundering can involve environmental offenses. Directive (EU) 2018/1673 explicitly lists environmental crime among criminal offenses related to money laundering^[3], recognizing its role in such processes. Directive (EU) 2024/1203 provides in Article 3 a catalogue of criminal offences relating to the environment, among which several concern waste, such as unlawful and intentional collection, transport or treatment of hazardous waste, or unlawful and intentional shipment of waste^[4].

Relevant EU sustainability disclosure frameworks

The analysis primarily examines four significant EU frameworks whose disclosures will be available on ESAP.

European Sustainability Reporting Standards (ESRS)^[5]: These standards apply to large and listed undertakings, mandating the disclosure of environmental, social, and governance (ESG) KPIs and narrative information. Disclosures must cover material impacts of disclosing entity on sustainability matters and how these matters affect the undertaking’s performance, focusing on impacts that are actual or potential, positive or negative, and assessed by severity and likelihood. ESRS disclosures form part of a sustainability statement in a management report to be published in a machine-readable format (iXBRL^[6])^[7].

Article 8 Disclosures Delegated Act^[8] (Article 8 DDA): Specifies content and presentation for large and listed undertakings’ disclosures on environmentally sustainable economic activities, also forming part of their management report to be published in iXBRL format^[9].

Sustainable Finance Disclosure Regulation^[10] (SFDR) and its regulatory technical standard^[11] (SFDR RTS): Applicable to financial market participants and advisors, SFDR requires disclosures on how sustainability risks affect investment value and returns, as well as any adverse impacts investments may have on the environment and society. These disclosures are found in product pre-contractual documents and in annual reports.

European Green Bonds Regulation^[12]: This regulation sets information requirements for issuers of bonds marketed as environmentally sustainable, including disclosures on bond factsheets, prospectuses, allocation reports, impact reports, and CapEx plans. These are made available on issuers’ websites until proceeds are fully allocated^[13].

The disclosures mandated by those frameworks are expected to be available on ESAP from 2028 (ESRS, Article 8 DDA, SFDR RTS) and 2030 (European Green Bonds Regulation).

Scenario 1: Detecting waste-related fraud

Waste-related fraud, involving the improper handling of waste, is a significant issue with estimated annual revenues from illicit non-hazardous waste trafficking in the EU ranged between EUR 1.3 billion and EUR 10.3 billion, and for hazardous waste trafficking between EUR 1.5 billion and EUR 1.8 billion^[14].

This scenario relates to the improper collection, transport, recovery or disposal of waste. Europol report identifies several fraudulent practices in waste management, including^[15]: relabelling or misclassifying hazardous waste as non-hazardous, fraudulent processing of waste, falsifying documentation for illegal export or sales, blending and concealment of illicit waste with legal materials, fake recovery/disposal or direct harmful disposal in nature or public areas. Waste crimes are often linked to other offenses like document fraud, corruption, and money laundering.

Relevant KPIs for detection in this scenario come from ESRS E5 Circular economy and SFDR RTS.

ESRS E5-5 Resource outflows mandates disclosures on an undertaking’s resource outflows, including waste, related to material impacts, risks, and opportunities^[16]. This includes^[17]:

• Total amount of waste generated.
• Total amount of waste by weight diverted from disposal, broken down by hazardous/non-hazardous and recovery operation types.
• Amount of waste by weight directed to disposal by treatment type (incineration, landfill, and other disposal operations), and the total amount summing all three types, with a breakdown between hazardous waste and non-hazardous waste.
• Total amount and percentage of non-recycled waste.
• Composition of waste, specifying relevant streams and materials^[18].
• Total amount of hazardous and radioactive waste generated^[19].

SFDR RTS requires disclosure of^[20]:

• Tonnes of hazardous waste and radioactive waste generated by investee companies per million EUR invested (Indicator 9, Table 1).
• Tonnes of non-recycled waste generated by investee companies per million EUR invested (Indicator 13, Table 2).

Possible detection method for waste-related fraud

The analysis suggests several methods to flag potential waste-related fraud:

1. Internal consistency check (ESRS E5-5), as any differences in ESRS E5-5 KPIs disclosed by a single undertaking for a given reporting period may be used to flag behaviour indicating possible fraud:

• Differences between the KPI on total amount of waste generated (KPI A) and the sum of KPI on the total amount of waste diverted from disposal (KPI B) and KPI on total amount of waste directed to disposal (KPI C). The disclosed value of KPI A shall be equal to the sum of KPI B and KPI C.
• Differences between the KPI on total amount of hazardous waste generated (KPI D) and the sum of KPI on the total amount of hazardous waste diverted from disposal (KPI E) and KPI on total amount of hazardous waste directed to disposal (KPI F). The disclosed value of KPI D shall be equal to the sum of KPI E and KPI F.

2. Anomalies in disclosed values under ESRS E5-5 KPIs:

• Low values of hazardous waste disclosed for undertakings that have economic activities in sectors related to generation of hazardous waste, such as mining, chemicals production, or construction and demolition^[21] may signal potential fraud.
• Significant fluctuations in hazardous waste amounts or waste directed to disposal between reporting periods for a single undertaking could flag potentially fraudulent activity.
• Composition of waste disclosure can help assess potential blending and concealment of waste (e.g. demolition materials in demolition activities) to disguise it and reintroduce into the economy.

3. ESRS and SFDR RTS data comparison

Crucially, direct comparison between ESRS and SFDR RTS data for fraud detection is not possible. ESRS disclosures on waste are made at the level of the disclosing entity’s own operations, while SFDR RTS data for waste KPIs is aggregated across all investee companies in an asset manager’s portfolio. This aggregation limits its usability for assessing individual undertaking performance in this context.

Scenario 2: Detecting green investments fraud

This scenario investigates a misuse of proceeds from a green bond and mislabelling of such financial instrument. The misuse of proceeds involves a case when funds raised by means of a financial instrument that is labelled as sustainable are not used to realise financial instrument’s sustainable objectives. Instead, such funds are diverted to non-sustainable activities, such as financing coal generated power instead of renewable energy. The resulting mislabelling of such financial instrument as sustainable involves greenwashing and green-related fraud. Therefore, in such scenario due to misuse of proceeds, misleading sustainability claims are made about real-world impacts of a financial instrument.

While National Competent Authorities (NCAs) supervise prospectus disclosures, specific sustainability disclosure requirements for prospectuses have historically been lacking, leading to varying interpretations. The European Green Bonds Regulation, adopted in 2024, aims to standardize requirements for bonds using the ‘European Green Bond’ designation.

Relevant KPIs for detection in this scenario are operational expenditures (Opex) and capital expenditures (Capex) KPs. These KPIs are crucial for verifying the commitment of resources to a financial instrument’s sustainable objective. Sustainability-related Opex examples may include costs for energy-saving lighting, GHG emissions monitoring, or environmental audits, while sustainability-related Capex can involve installing solar panels, building wind turbines, or upgrading machinery for energy efficiency.

All four assessed frameworks mandate Opex and Capex disclosures.

ESRS 2 requires disclosure of significant Capex and Opex per action plan, that are related to sustainability matters, including current and future amounts and financing details from sustainable finance instruments^[22]. ESRS E1-1 also requires information on transition plans and their funding^[23].

Article 8 DDA mandates disclosure of Capex and Opex for products or services associated with environmentally sustainable economic activities, per specific activity^[24], and requires a Capex plan.

SFDR RTS requires financial market participants to describe investments in environmentally sustainable activities, including whether Capex or Opex KPIs are used, and to graphically represent aggregated investments, Capex, and Opex of non-financial investee undertakings^[25].

European Green Bonds Regulation necessitates disclosures on the use of bond proceeds, including a Capex plan and annual allocation reports detailing how proceeds contribute to Capex and Opex of sustainable projects, groups of projects, or economic activities^[26]. It also links to Article 8 DDA Capex/Opex disclosures^[27] if applicable, and ESRS transition plans^[28].

Possible detection method for green investments fraud

European Green Bonds Regulation forms a primary basis for detection. Opex and Capex KPIs disclosed in a bond issuer’s Capex plan and annual allocation report can help identify inconsistencies. Such inconsistencies may include differences between the values declared in the Capex plan and the actual allocation of bond proceeds to Capex and Opex for a sustainable project, group of projects, or economic activity, thereby flagging potential misallocation of resources

Additionally, disclosures in the annual allocation report, which include information on the amount of bond proceeds allocated to Capex and Opex of sustainable activities as defined by the EU taxonomy^[29], can help flag mislabelling of a bond as green. This would be the case when bond proceeds are granted to energy generation based on coal rather than to renewable energy generation.

ESRS 2 Opex and Capex disclosures offer limited value for verifying actual allocation of green bond proceeds due to differing scopes (ESRS disclosure applies to action plan, while European Green Bonds Regulation disclosures are at a level of a project, group of projects or an economic activity).

Verification of European Green Bonds Regulation disclosures on Capex against Article 8 DDA Capex and Capex plan is only possible if the entity finances expenses through green bonds and if the European Green Bonds Regulation disclosures are made per economic activity. If disclosures are project-based, comparison becomes impossible.

Opex and Capex disclosures under SFDR are not useful for assessing individual fraud cases as the data is aggregated across an asset manager’s portfolio.

Key insights

The analysis provides a methodology for flagging potential green-related fraud or greenwashing and confirms that selected sustainability-related KPIs can serve as valuable warning signs. In high-risk sectors, like waste disposal, such flags may indicate cases for more in-depth money laundering assessments.

The analysis has also identified certain caveats that limit the scope of the assessment, such as limited scope of disclosures, or that discrepancies can reflect reporting immaturity, inaccurate accounting, omissions or errors. In addition, currently those KPIs are dispersed across entity websites or business registers. The full potential for comprehensive fraud detection will be unlocked with the gradual implementation and centralization of those data on ESAP from 2028-2030.

Despite such limitations, this analysis provides a backbone of a methodology for identifying green-related fraud and greenwashing. As ESAP would enhance transparency and comparability, compliance teams and financial intelligence units should proactively develop methodologies to leverage sustainability disclosures for green-related fraud and greenwashing detection.