Table of contents:
The European Securities and Markets Authority (ESMA) now requires investment firms providing Portfolio / Wealth Management and / or Investment Advice to:
Collect information from clients on sustainability preferences: Firms will need to collect information from clients on their preferences in relation to the different types of sustainable investment products and to what extent they want to invest in these products.
Assess sustainability preferences: Once the firm has identified a range of suitable products for client, in accordance with the criteria of knowledge and experience, financial situation and other investment objectives, it shall identify – in a second step – the product(s) that fulfil the client’s sustainability preferences.
Updates to the Markets in Financial Directive (MiFID) II and the Insurance Distribution Directive (IDD)
From 2 August 2022 investment firms must take sustainability risks into consideration during all decision-making procedures. Furthermore, when providing financial advice, they must acquire sustainability preferences from clients as part of the suitability process. It is the responsibility of advisers and portfolio managers to discover the following points:
The extent to which their client is sustainably conscious
The objective of their current or proposed investment and how it is meeting its environmental, social, and governance (ESG) considerations
The policies and procedures used to provide advice must demonstrate sustainability factors.
Suggested Steps to be Taken to Ensure Compliance With This Requirement
To serve the client/investment broker relationship properly, it is recommended that the following processes are added at the initial stage of establishing the relationship, when completing the profile:
Customer Due Diligence (CDD)
Know Your Customer (KYC)
The information should be stored accordingly and appropriately using the regular review process to update as required.
In relation to existing clients, a review should be undertaken forthwith, and their profile updated with the information gathered.
It is suggested that it should be recorded if the client does not wish to engage in sustainable investing.
Discovering a Client’s Views on Sustainable Investing
ESG should be used as the topic to frame the questions to assess a client’s position on sustainable investing. Here are some examples of the type of questions that could be used:
Which do you consider to be more important - incorporating ESG-compliant investments or maintaining returns on your portfolio?
Which is more significant to you – divestment from non-ESG-compliant companies, investment in ESG-compliant companies, or both?
Would you consider investing in a company that creates a negative environmental impact now but is investing extensively in sustainable operations?
Would you favour investing in companies that currently have a large carbon footprint but have committed to investing in future sustainability, or companies that presently have a smaller carbon footprint but don’t plan to reduce their carbon footprints in the future?
Given the choice between a company that specifically observed governance and human rights and a company that was committed to reducing its carbon footprint, which would you choose?
Would you be prepared to invest in a company that actively worked to reduce its carbon footprint but had a lesser regard for human rights?
Which of the elements of ESG (Environmental, Social, Governance) would you disregard if you were only allowed to invest in two of these?
If sustainability preferences take precedent over a client’s conventional investment objectives, this may result in mis-selling. Therefore, sustainability preferences should be addressed within the suitability process only once the client’s conventional investment objectives, time horizon and individual circumstances have been identified.
Incorporating Client ESG Preferences into Suitability Assessments
It is suggested that investment providers/portfolio fund managers will face several important challenges incorporating a client’s ESG preferences into their suitability assessments. Firms should consider the following key questions in thinking through their implementation of these important new rules:
What is our in-house strategy on sustainability, and how can we ensure our advice and product offerings are joined up with the ESG questions we ask of clients in our suitability assessments?
What are the E, S and G issues which are material to our product offering? Do we need to expand or modify our product offering?
Do we want to include the modifications into our existing suitability questionnaires, or would a different form of assessment be more practical?
How extensive does the questionnaire need to be? Do any aspects of the process risk the perception of greenwashing?
What type of performance scenarios will we utilise to explain ESG related risk/return trade-offs to clients? How will we satisfy ourselves of the accuracy of the data used for these? Is there a need to disclose data limitations to clients?
Which types of responses on the questionnaire match which products? And if there are indications of contradictions within, what time frame do we want to follow up with clients?
Under what circumstances and how often must clients update us on their preferences (outside of the annual update)?
Do we have enough information about the costs of switching products and has this been made clear to clients?
As always, clear and detailed records of the annual process will not only help in demonstrating compliance to the regulator but will also provide an audit trail that can be referred to in case clients wish to discuss or amend strategies in due course.
FAI Comply can assist with the implementation of procedures to ensure your firm maintains regulatory compliance considering these new rules. Please contact us to discuss your requirements.