A growing interest for sustainable investing
Climate change, health crisis and social tension have increased the interest of professional and retail investors for more sustainable investments over the past 5 years.
Investors now seek a positive impact on their environment through everyday purchases, but also through investing.
According to DeVere’s research, 80% of Millennials are aiming to invest in environmentally or socially minded products, compared with 60% for the rest of the population.
To address this growing demand and avoid green washing, the European Securities and Markets Authority (ESMA) will make it compulsory in 2022 for investment firms to integrate the assessment of sustainability preferences in the existing client suitability assessment process.
A new regulatory pressure to assess sustainability preferences
This new rules from the European Commission will more specifically amend the Insurance Distribution Directive (IDD) and the Market in Financial Instruments Regulations for Investor Protection (MIFID II).
Today, under these regulations, financial institutions need to have a clear understanding of their clients’ investor preferences to recommend suitable financial products in case of portfolio management or investment advice.
More precisely, financial advisors have to ask questions about their clients’ financial situation, financial expertise, investment objectives and risk preferences.
With these new requirements, financial advisors will have, when giving advice, to take into account the interest of their clients for sustainable finance.
This will involve disclosing relevant information about the sustainable risks and features of the investment products or services that the investor has been recommended. These requirements will apply to both new and existing clients.
This appetence for sustainable products is sometimes referred as “ESG preferences” or “sustainability preferences” or sometimes “SRI preferences”.
The difference between these three terms is not always obvious and they are frequently as synonyms.
ESG, SRI and sustainability preferences, what is the difference?
The ESG acronym means Environmental, Social and Governance.
ESG investing thus refers to a client’s preference for responsible investments with a positive impact on the environment, on the society or on godd governance.
Socially responsible investing (SRI), also known as social investment, is an investment that is considered socially responsible due to the nature of the business the company conducts.
Socially responsible investments include eschewing investments in companies with social benefits that produce or sell addictive substances (like alcohol, gambling, and tobacco) in favor of seeking out companies that are engaged in social justice, environmental sustainability, and alternative energy/clean technology efforts.
The idea of SRI investments is to have a positive impact on society, while maintaining a respectful balance with the environment.
Sustainability preferences have a broader definition than SRI or ESG preferences since they designate the appetence of clients for sustainable products in general, including for ESG or SRI products.
ESG, SRI and sustainability preferences, what is the choice of the regulator?
In the first drafts of the European Securities and Markets Authority (ESMA), the term of ESG was used. The term of SRI has apparently never been used.
Firms should have in place appropriate arrangements to ensure that the inclusion of ESG considerations in the advisory process and portfolio management does not lead to misselling practices, including as an excuse to sell own-products or more costly ones, or to generate churning of clients’ portfolios, or to misrepresent products or strategies as fulfilling generate churning of clients’ portfolios, or to misrepresent products or strategies as fulfilling ESG preferences where they do not.
Later, in the 2021 delegated act, the ESMA switched for the term of sustainability preferences.
“sustainability preferences” means a client’s or potential client’s choice as to whether and, if so, to what extent, one or more of the following financial instruments shall be integrated into his or her investment:
(a) a financial instrument for which the client or potential client determines that a minimum proportion shall be invested in environmentally sustainable investments as defined in Article 2, point (1), of Regulation (EU) 2020/852 of the European Parliament and of the Council (*);
(b) a financial instrument for which the client or potential client determines that a minimum proportion shall be invested in sustainable investments as defined in Article 2, point (17), of Regulation (EU) 2019/2088 of the European Parliament and of the Council (**);
(c) a financial instrument that considers principal adverse impacts on sustainability factors where qualitative or quantitative elements demonstrating that consideration are determined by the client or potential client;
We did not find the reason of this change of terminology. Maybe it is due to the fact that the notion of sustainability is broader than the notion of ESG. Anyways, to be fully in line with MiFIDII, the term “sustainability preferences” seems now to be more appropriate.