The EU’s ambitions for sustainable finance touch most areas of financial services. The European Commission established a high-level expert group in 2016 with the goal of developing an EU strategy on sustainable finance, which concluded that environmental, social and governance considerations had to be considered. The group’s recommendations included a technical classification system, resulting in the proposed Taxonomy Regulation, which seeks to establish a common language to identify and standardise what is “environmentally sustainable”.
In March 2019, agreement was reached on the Disclosure Regulation, which seeks to remedy the lack of transparency in how institutional investors, asset managers, and financial advisers consider sustainability risks in their processes.
There are three categories of covered firm. Firstly, financial market participants: AIFMS, portfolio managers, Ucits managers, an IORP-qualifying occupational retirement scheme, a provider of a pension product, an insurer which makes certain products available, EuVECA, and EuSEF managers. Also, insurance intermediaries and MiFID investment advisers.
Broadly, all obligations under that regulation would apply to financial market participants and most would apply to the other two categories. Covered firms should publish and maintain written policies on the integration of sustainability risks in the investment decision-making or advisory process on their websites. They should also provide investors/clients with pre-contractual disclosures including procedures and conditions applied for integrating sustainability risks in investment decisions and the extent to which sustainability risks are expected to have a relevant impact on returns. This is in addition to how their remuneration policies are consistent with the integration of sustainability risks and are in line with the sustainable investment target of the product.
The Commission published a draft regulation under MiFID in January 2019 on how portfolio managers and financial advisers should take sustainability into account when assessing suitability. Under MiFID II, investment firms providing investment advice or portfolio management are required to provide suitable personal recommendations to their clients or make suitable investment decisions on behalf of them. Suitability has to be assessed against clients’ knowledge and experience, financial situation and investment objectives.
However, ESG issues are not normally considered under the current suitability regime. The draft regulation requires firms to identify their clients’ ESG preferences so that their service reflects the clients’ financial objectives and ESG preferences. It states there will not be a requirement for existing sustainability assessments to be revisited and contemplates a 12-month transitional period, sweetening the implementation pill. That said, in May 2018, Esma recommended that firms should consider ESG factors when gathering information on a client’s objectives, paving the way for investment firms to volunteer to include ESG preferences in their suitability assessments.
These developments form part of a continuing endeavour by European lawmakers to lay the foundations for an EU framework that puts ESG considerations at the heart of the financial system.
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