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.
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.
We summarize below the main takeaways of the publication.
Since 2012, the European Securities and Markets Authority (ESMA) has 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
Assessing preferences for responsible investments
Under MiFID II, 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) 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 ;
b) 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;
c) 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.
A definition of sustainability preferences and of ESG (Environment, Social, good Governance) should be included in the MiFID II questionnaire. Technical terms should be avoided.
What kind of information should be collected from the clients?
ESMA considers that the level of information to be collected from clients should include all aspects mentioned in the definition of “sustainability preferences”
When should sustainability preferences be collected?
Sustainability preferences should be collected after the current client suitability assessment process (financial situation, financial expertise, investment objectives, risk tolerance).
This assessment could be performed during the first meeting with the client and updated as part of the next regular update of the client’s profile.
Is there a difference in case of investment advice and portfolio management?
No, investment firms should ensure the same level of granularity of information in case of portfolio management or investment advice.
What about 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.
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.
What to do if no products match the clients’ sustainability preferences?
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.
Which methodology should be used?
Throughout the process, firms should adopt a neutral and unbiased approach as to not
influence clients’ answers.
Should sustainability preferences be assessed at the portfolio or at the financial instrument level?
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.
What happens if a client has no ESG preferences?
In this case, the financial firm may recommend products both with and without sustainability-related features. The choice of the client should be documented.
The consultation closes on 27 April 2022. The European Securities and Markets Authority (ESMA) expects to publish a final report in Q3 2022.