Are you ready for the new responsible and sustainable investments regulations?

In this article we outline how the upcoming regulatory changes will impact your advice process and highlight the key issues you’ll need to consider when preparing for them. FOR ADVISER USE ONLY.

26 January 2021

One of the positives from 2020 was the increasing engagement in investing for good from across the investment industry. With new regulations set to bake ESG considerations into the advice process and clients increasingly conscious of the impact their investments have on the world, ESG looks set to be an even more crucial topic for financial advisers in 2021 and beyond.

How will the regulation changes affect you?

Last year, the EU Commission asked the European Securities and Markets Authority (ESMA) to propose changes to MiFID II, AIFMD and UCITS to bring the investment industry and financial advice firms into line with the UN’s Sustainable Development Goals and the Paris climate agreement. The MiFID II changes are aimed at advisers and are expected to be written into the Official Journal in the first quarter 2021. 

Why is this still relevant now that we aren’t in Europe? These may be European rules, but they have been developed in conjunction with UK authorities. Unsurprisingly, the FCA has indicated that it intends to "match the ambition of" MiFID II and sustainability legislation, even though we have left the EU. This means that UK legislation will require advisers to assess sustainable investment preferences prior to making a recommendation. Any investment recommendations will need to be supported by a process that has considered responsible investment factors, such as sustainability risk, and your fact find and advice letter will need to demonstrate the consideration of sustainability risks. So even if your clients are not interested in ESG, you will still need to have knowledge on the sector and a suitable policy in place.

There are a number of important factors that we think advisers will need to consider as part of their advice process in light of the new regulations:

  1. Complexity – With new rules, new terminology and new process requirements, there is an enormous compliance burden on financial advisers. Simple oversights in each area could have implications with the regulator or for client complaints.
  2. Definitions – This is without doubt the issue we get questioned on the most. New terminology including ESG, sustainability, exclusions, minimising, impact investing and positive investing are just the tip of the iceberg. Being able to handle complex value discussions on each of these can be a daunting task.
  3. Greenwashing – A term which is used for investments that claim to be green but do not actually fulfil their sustainable intentions. An example of this is where an investment or a fund cuts out tobacco but only does so with a small proportion of its investments.
  4. Negative versus positive investing – The nuances of responsible investment can cause contention between different approaches to investing for good. Suppose you take a company with a high carbon footprint; on one hand that is bad, but if the company is making strides to improve, it is good. So where does it fall? Bad or good, should it be filtered out, or engaged with to continue its progress
  5. Process and governance – The FCA is well known for creating frameworks, allowing the industry to decide and produce creative solutions to complex issues. Ensuring that you have a robust process in place with sound, detailed reporting will be essential to meet the spirit of the regulations.
  6. Fact find, suitability and advice – By far the most under-appreciated element of the changes, many advisers have not considered if the rules should apply to non-ESG solutions. The MiFID II rules indicate that the “vanilla” portfolio offerings should consider ESG and sustainability. This should be baked into your process and the advice letter should consider the risks, even if sustainable investment options have not been established in the fact find, along with the reasons why.
  7. Suitability and investment risk versus sustainability risk – How should you consider and weigh these risks against each other. Should your client suffer returns for sustainable investing, how are the risks balanced and taken into consideration?
  8. Timing of discussions about sustainability - The new regulations state that client attitude to sustainability needs to be included in the fact find but should a detailed discussion be held at this stage, or should you defer it to the recommendation stage?
  9. Ongoing reporting – Getting the message through to clients is fundamental. How are you going to tell the story and frame the impact their portfolio is having on the world? The right support with timely, appropriate information will make your job easier and save time.
  10. Track record – Does your DFM have a track record in this sector?  Responsible investment portfolios can look very different from a “vanilla” portfolio. DFMs need to adapt and have a successful strategy to balance conscientious investing with risk and return.
Finding an ESG solution that works for all your clients will require some compromise." 

Even if you feel you already have some knowledge of the sector and are providing an ESG solution to some clients, scaling this process for your entire client bank is likely to bring complications. Especially considering the differing priorities that each client will have and the diverse nature of the funds and portfolios in this sector.

To be able to offer an ESG solution at scale, some compromise around your clients’ priorities is inevitable. Without the right process in place, finding the best fit for your clients and then balancing that against performance will be a never-ending task and it will be easy to get bogged down in the detail.

How can FE Investments help?

We believe the best way to create a strong, conscientious, and scalable investment philosophy is by simplifying the process. Our Responsibly Managed Portfolios use our proven investment philosophy and process but adjusted to select funds that aim to do good for society. The portfolios cover a spectrum of investment strategies that aim to deliver a positive effect from investing via three important premises:

  1. Do less harm
  2. Do more good
  3. Consider the risk and return requirements for investors

This process is designed to simplify a nuanced and complex subject, to support your advice process and make managing your clients easier. The portfolios are pragmatic and transparent to help you find the solution that best meets your clients’ needs.

We strongly believe in communicating in a clear and simple manner, creating reports that are concise and distinctive, making investments easier for your clients to understand. Our reports have been designed to tell a meaningful story and responsible investing criteria are included to give clients greater insight into the impact their investments have on the world.

Launched back in 2017 when ESG solutions from discretionary managed portfolio providers were in their infancy, our Responsibly Managed range has the three-year performance data that’s so important for advisers’ analysis. Designed with financial advisers in mind, the range caters for investors with differing risk profiles and time horizons. It includes a choice of 15 portfolios – with five risk-optimised portfolios each spanning three investment time horizons.

Click here to learn more about the Responsibly Managed Portfolios or on the link below to request our client guide and speak to one of our experts.

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