Asking investors about their preferences for sustainable investing should become part of the routine for financial advisors and asset managers from August 2022.
The European Commission adopted last year a Delegated Regulation to the introduce the assessment of suitability in the Markets in Financial Instruments Directive (MiFID) suitability questionnaires and in the Insurance Distribution Directive (IDD).
This new requirement applies for investment firms on regulated markets providing investment advice or discretionary portfolio management services (i.e. pension funds, banks, life insurance companies…).
On the 27th of January 2022, the European Securities and Markets Authority (ESMA) published a consultation paper to propose guidelines on how to incorporate sustainability preferences assessment in the client suitability process. The consultation closes on 27 April 2022 and the final report is expected for Q3 2022.
On the 13th of April, the European Insurance and Occupational Pensions Authority (EIOPA) similarly launched a public consultation on draft Guidelines on integrating the customer’s sustainability preferences in the suitability assessment under the IDD. The submission deadline is the 13th of May 2022 in order to publish the final version of the guidelines in July 2022.
The first guidelines mainly apply for banks and wealth management companies while the second guidelines apply for insurance companies.
We compare below the two guidelines.
Context
Since 2012, the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) have already published a couple of guidelines about client suitability assessment in order to:
- regulate the growing market of robo-advisors and automated advisory platforms
- build on NCAs’ supervisory experience on the application of suitability requirements;
- take into account the outcome of studies in the area of behavioral finance;
The main objective of these new guidelines from the European Union is to share good and bad practices around the assessment of sustainability preferences
Objectives
Under MiFID II and IDD, financial firms should assess the investment profile of their clients before making any investment decisions. More precisely, the below pieces of information should be captured:
- Client’s experience and knowledge
- Client’s financial situation and capacity to bear any investment risk
- Client’s risk tolerance
- Client’s investment objectives
The Delegated Regulation has added to this last point the consideration of the “possible sustainability preferences” of the investor, in order to promote sustainable investment.
“Sustainability preferences” refers to:
- a financial instrument that is invested in environmentally sustainable investments, as defined in Article 2(1) of Regulation (EU) 2020/852 of the European Parliament and f the Council (*), in a minimum proportion determined by the client or potential client ;
- a financial instrument which is invested in sustainable investments within the meaning of Article 2(17) of Regulation (EU) 2019/2088 of the European Parliament and the Council (**) in a minimum proportion determined by the client or potential client;
- a financial instrument that addresses key adverse impacts on sustainability factors, with the qualitative or quantitative elements that demonstrate this being determined by the client or potential client.
To avoid greenwashing, investors’ sustainability preferences as defined above should be collected under IDD and MIFIDII and investment products should not be recommended if they do not meet their individual sustainability preferences.
Similarities
Time to collect sustainability preferences
Sustainability preferences should be collected after the other elements of the client suitability assessment process (financial knowledge and experience, financial situation, objectives, risk tolerance).
Sustainability preferences should be updated when the information on the customer is being updated or at the time of a regular periodic assessment (as for the other elements of the client suitability assessment).
Financial education
A definition of sustainability preferences and of ESG (Environment, Social, good Governance) should be included in MiFID II or IDD client suitability questionnaires. Technical and misleading terms should be avoided.
Intermediaries should allow for providing more granular information if the customer requests it. The explanations should be given prior to collecting sustainability preferences.
No sustainability preferences
When the client does not express any sustainability preferences, the decision should be recorded and the financial firm can proceed with a recommendation.
Under MIFIDII and IDD, the financial firm may recommend products both with and without sustainability-related features.
Product matching
If no products match the sustainability preferences of the client, the client should be invited to change his or her sustainability preferences to invest in products offered by the financial institutions.
ESMA considers that firms can still recommend products that do not meet the sustainability preferences of the client only once the client has adapted such preferences. The firm’s explanation and the client’s decision should be documented in the suitability report. It should be noted that this possibility should only refer to the sustainability preferences and not to the other criteria of the suitability assessment. (…)
The adaptation of the client’s “sustainability preferences” where financial products do not meet such preferences should only refer to the suitability assessment in question/to the particular transaction and not to the client’s profile in general. (…) If the client states that he/she has sustainability preferences, and the firm does not have any products with sustainability related factors available, this should also be documented in the suitability report.
European Securities and Markets Authority (ESMA)
Commission Delegated Regulation (EU) 2021/1257 introduces the possibility for the customer or potential customer to adapt the sustainability preferences in the case where no IBIP is made available by the insurance undertaking or insurance intermediary that meets the customer’s sustainability preferences.
EIOPA clarifies that insurance undertakings or insurance intermediaries providing advice on insurance-based investment products are required to record all relevant information about the situations where a customer’s sustainability preferences are adapted, including a clear explanation of the reasons for such adaptation.
European Insurance and Occupational Pensions Authority (EIOPA)
Unbiased approach
In both guidelines, the regulators insist on the fact that sustainability preferences should be captured in an unbiased manner, in line with previous guidelines promoting the use of behavioral finance.
Throughout the process, firms should adopt a neutral and unbiased approach as to not influence clients’ answers.
European Securities and Markets Authority (ESMA)
Differences
Reference base to capture sustainability preferences
For both insurance and wealth management companies, a portfolio of different financial instruments can be recommended (ex: a combination of euro funds and UCs for a life insurance product). It is thus necessary to know on which basis sustainability preferences should be collected. Is at the financial instrument or at the portfolio level?
The two guidelines have different approaches on this matter.
Under MIFIDII:
Where the client wishes to include more or all of the aspects mentioned under a) to c) of Article 2(7) of the MiFID Delegated Regulation, this could be either assessed and matched on portfolio level or on the level of the financial instrument, depending on the service provided.
European Securities and Markets Authority (ESMA)
Under IDD:
In order to collect information on the minimum proportion invested in environmentally
sustainable investments as defined under the Taxonomy Regulation, insurance undertakings and insurance intermediaries should ask the customer whether the Taxonomy-alignment should be based on all the investments of the insurance-based investment product, or only on the assets that are not government bonds.
European Insurance and Occupational Pensions Authority (EIOPA)
The specificities of multi-option products required to develop a specific proposal for the collection of information. In particular in the guidelines EIOPA provides guidance on how to obtain information on the preference with regard to principal adverse impacts. Insurance undertakings and insurance intermediaries should collect information from the customer on whether all underlying options should consider PAI of investment decisions on sustainability factors, or only a proportion or a selection of one or more underlying options.
European Insurance and Occupational Pensions Authority (EIOPA)
If applicable, insurance undertakings and insurance intermediaries should explain to the customer that government bonds may help to reduce the volatility the investment return of the insurance-based investment product
European Insurance and Occupational Pensions Authority (EIOPA)
Calculation of the percentage of alignment to the Taxonomy and to SFDR and PAIs in the case of a portfolio
While the ESMA draft guidelines do not give a clear methodology on how to calculate the the percentage of alignment to the Taxonomy and to SFDR and PAIs in the case of a portfolio, the EIOPA share further information:
with regard to the sustainability preferences of the customer under points a) and b) of Article 2(4) of Commission Delegated Regulation (EU) 2017/2359, assess whether the weighted (per premiums) average of minimum proportion of environmentally sustainable investments or sustainable investments in the selected underlying options of the multioption product matches the minimum proportion expressed by the customer.
with regard to the sustainability preferences of the customer under point (c) of Article 2(4) of Commission Delegated Regulation (EU) 2017/2359, ensure that at least one of the selected underlying options considers principal adverse impacts during the duration of the contract and, in all cases, take into account the sustainability preferences determined by the customer in accordance to point 10.
European Insurance and Occupational Pensions Authority (EIOPA)
Self-assessment
In previous guidelines, the ESMA warned about the use of self-assessment to assess clients’ investment preferences.
To assess financial expertise, the use of a quiz was recommended to capture clients’ true financial knowledge.
To assess risk tolerance, the use of behavioral finance questionnaires was recommended to avoid any cognitive biases.
Regarding the assessment of sustainability preferences, the approach suggested for the moment for gathering information from clients on their sustainability preferences is substantially based on self-assessment.
The EIOPA does not share any point of view on this matter, apart from the fact that sustainability preferences should be collected in a ‘unbiased manner”.
Use of ranges to capture the alignment to the Taxonomy and SFDR
EIOPA is of the view that ranges should not be used to capture the desired alignment to the Taxonomy and to SFDR. If necessary, standardized minimum proportion can be used (ex: minimum of 10%, minimum of 20%,…). The ESMA does not share any views on this matter in the current draft guidelines.
Collection of Principal Adverse Impacts
The Delegated Regulation mentions that a financial instrument can be considered as a sustainable product if it “addresses key adverse impacts on sustainability factors, with the qualitative or quantitative elements that demonstrate this being determined by the client or potential client.”.
The EIOPA clarifies this point by saying that the client should not only select the PAIs he or she wants to take into consideration, but also explain for each of them the quantitative and qualitative criteria demonstrating that consideration. ESMA does not share this kind of details in its current draft.
In both guidelines, the use of meta-categories of PAIs is permitted.
In case the customer wishes to invest in an insurance-based investment product or in underlying investment options that consider PAI, the information collected should cover the PAI and qualitative or quantitative elements mentioned in point c) of Article 2(4) of Commission Delegated Regulation (EU) 2017/2359.
European Insurance and Occupational Pensions Authority (EIOPA)
Insurance undertakings and insurance intermediaries should test the customer’s preferences and appetite for PAI integration with regard to the families of PAI indicators as a whole, based on a possible focus of the customer on environmental, social or governance aspects, using the categories set out in Commission Delegated Regulation of 6.4.2022 supplementing Regulation (EU) 2019/2088 such as emissions, energy performance, water and waste, social and employee matters, human rights (instead of an approach based on each PAI indicator). An evaluation could then be initiated for each category that is important for the customer. This evaluation should be based on the approaches in which products consider PAI (e.g. exclusion strategies, controversies policies, voting and engagement policies).
European Insurance and Occupational Pensions Authority (EIOPA)