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New ESMA suitability guidelines, but its advisory group is not impressed

At the end of September, the European investments regulator ESMA published its final report on “guidelines on certain aspects of the MiFID II suitability requirements”. The focus of the guidelines is the integration of clients’ sustainability preferences into suitability assessments and the integration of sustainability risks into firms’ organisational requirements.

Before going any further, it is important to remember that these guidelines apply in the EU, but not the UK. In the UK, we have just had the FCA’s Sustainability Disclosure Requirements (SDR) consultation paper published and it has gone further than last year’s discussion paper in respect of distributors’ obligations. While not being expected to incorporate clients’ sustainability preferences, distributors in the UK will be expected to play their part in combating greenwashing.

After assessing the suitability of any investments based on the client’s knowledge and experience, financial situation (including ability to bear losses) and investment objectives, firms should then consider a client’s sustainability preferences. To match the client’s sustainability preferences, a product’s sustainability factors should be assessed in terms of the proportion invested in environmentally sustainable economic activities as defined in the Taxonomy Regulation, the proportion of sustainable investments as defined in the Sustainable Finance Disclosure Regulation (SFDR), or its consideration of principal adverse impacts (PAIs) and other ESG sustainability features.

A product should not be recommended or sold to a client unless its sustainability factors meet the client’s preferences, as doing so (unless the client has updated their preferences and this has been documented) would put the firm in breach of its MiFID II obligations. To avoid such possible breaches, firms should ensure staff have the necessary skills, knowledge and experience of sustainability preferences and factors and firms should also have in place policies and procedures for any customer-facing staff. If relevant, these should also be factored into any robo-advice services offered.

Although the MiFID II requirements to include clients’ sustainability preferences came into effect on 2 August this year, these new guidelines won’t come into effect until six months after they have been translated into all the official EU languages and published on the ESMA website. Within two months of that publication, national regulators must inform ESMA if they comply, or intend to comply, with the guidelines.

Meanwhile, the ESMA report also included the advice of its own Securities and Markets Stakeholder Group (SMSG), which consists of industry and consumer representatives and academics. Their comments were not particularly positive. Their main criticism was of “a mismatch between expectations of clients and the availability of products” because of the lack of adequate and reliable data on the companies held by investment products, making it “almost impossible for financial institutions to go beyond a ‘best effort‘ compliance”, which is “neither appropriate nor desirable”.

The SMSG was also unimpressed by the delegated regulation defining the criteria to assess sustainability preferences: “If guidelines were written from a blank sheet, the outcome would probably be different”. The group suggests that ESMA “investigates alternative ways to assess sustainability preferences, also taking into account insights from behavioural finance”, as sustainability preferences are complex and the criteria being used are neither the way clients think about sustainable investment nor the way funds operate.

It was suggested that other concepts, such as engagement, best in class and approaches to sustainable transition should feature, rather than the rigid quantitative approach to PAIs.

Like much else around sustainability disclosures, this is unlikely to be the final iteration, something the SMSG also emphasised: “it is also important that guidelines that ESMA publishes are drafted in such a way that they help firms and clients, at the stage of the process they are at, even if that means that the guidelines may have to be updated at regular intervals”.

In line with the SMSG’s concerns, we are seeing fund groups struggling with a lack of good quality data, which is particularly important for Article 9 funds (having sustainable investment as an objective) as the rules on what they can invest in are much tighter than for other funds. We have written before on the challenges facing those funds on retaining their Article 9 status.

FE fundinfo is supporting fund managers with the collection and creation of the European ESG Template (EET), the dissemination of EET required data fields and documents to a global network of distributors and with the creation of ESG Marketing and Regulatory documents, including SFDR (EU) and TCFD (UK) reports.

Fund distributors can access whole of market EET data via FE fundinfo’s Data Feed Portal enabling the industry to meet international ESG reporting and disclosure requirements.

For more information, contact our ESG specialists:

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