Risk appetite, financial situation, level of experience, and financial knowledge… Introduced in 2007, MiFID regulations require financial institutions to know the investor profile of their customers. The objective? To ensure that customers understand the financial products on offer and that they correspond as closely as possible to their expectations. Since then, MiFID (Markets in Financial Instruments Directive) regulations have been constantly enriched to offer ever greater transparency and protection to investors. Following the financial crisis, MiFID I was improved to become MiFID II: a strengthened regulation applicable to all investment products. Among the many changes made to the text, some concern the consideration of investors’ ESG preferences. Thus, from August 2022, financial advisors will have to inquire about the impact sought by clients through their investments, to offer them adapted financial products. In other words, banks, asset management companies, and investment advisory firms must now capture clients’ ESG preferences in their suitability questionnaires. What form should this assessment take? What do financial institutions need to put in place to comply with the latest MiFID 2 adjustments? We take stock.
From SFDR to MiFID 2: how sustainable finance made its way into regulation
Implemented on 10 March 2021, the SFDR regulation has introduced the need to classify financial products according to their impact, in line with the EU’s drive to establish a green taxonomy of financial products. In particular, the SFDR defines two categories of products:
- products that promote ESG characteristics (Article 8)
- products with a sustainable investment objective (Article 9)
At the same time, investor interest in sustainable finance has never been higher. In this context, the EU has proposed changes to MiFID II to ensure that investors’ ESG preferences are considered in the suitability assessment. As a reminder, the MiFIDII suitability questionnaire should already provide information on:
- Financial objectives
- Risk profile (including ability and willingness to take losses)
- Financial literacy
- Clients’ investment experience
From now on, it will therefore also have to include questions on the sustainability preferences / ESG preferences of clients. ESG preferences are defined in the regulations as a client’s choice to include financial products that comply with Article 8 or 9 of the SFDR in their investment strategy.
MiFID 2 questionnaire and ESG preferences: what information should be collected?
The European Securities and Markets Authority (ESMA) stipulates that all “necessary information” must be collected before providing investment services, in two distinct areas.
1. The client’s ESG strategy
The concept of sustainable investment is vague. From one client to another, the desired ESG strategy can differ greatly. Banks and investment advisory firms, therefore, need to ask several questions to understand at a very fine level their clients’ expectation, such as:
- How much of your assets do you want to invest?
- Do you want to modify existing portfolios or dedicate separate amounts?
- Do you prefer to invest in E, S, or G compliant companies or simply remove certain types of non-compliant stocks from your portfolios?
Some clients will want to invest in companies that harm the environment but invest in sustainable operations. Or conversely: companies with a low negative impact, but which do not necessarily invest in sustainable operations.
2. Preference between E, S, and G
Environmental, social, and governance issues: ESG products cover a wide range of products. However, clients may only want to invest in one or two of the three ESG components, or they may favor certain factors over others. The MiFID II questionnaire should therefore identify which E, S, or G criteria are most important to the investor. For example, it would be interesting to ask a client who wishes to invest in companies with good governance whether he would be satisfied if these companies had a low score in terms of environmental contribution. Asking this type of question is essential to understanding the trade-offs that investors are willing to make, and thus helps to refine the analysis of ESG preferences.
ESGprofiler: a simple solution to capture investors’ ESG preferences, in compliance with MiFID 2 regulation
Specializing in behavioral finance, the start-up Neuroprofiler has developed a unique tool to accurately assess investors’ ESG preferences. Called “ESGprofiler”, this fun and adaptive questionnaire enables financial institutions to gain a detailed understanding of the impacts sought by clients in their investments, and also to identify the sectors they wish to exclude.
Rather than adding lines to already lengthy compliance questionnaires, the use of the ESGprofiler allows for full compliance with the latest MiFID II provisions, while turning this regulatory exercise into a business opportunity. Indeed, advisors can use this regulatory pretext to learn more about their clients’ preferences, and thus offer them perfectly adapted financial products to boost their savings. Using the ESGProfiler can boost sales of ESG products and achieve a customer conversion rate of 10% from euro funds to unit trusts! To see for yourself, just ask for a demo!