Proposed changes seek to reflect the integration of sustainability considerations into MiFID II.
By Nicola Higgs, Anne Mainwaring, Dianne Bell, and Charlotte Collins
The European Securities and Markets Authority (ESMA) is consulting on updates to its Guidelines on the MiFID II suitability requirements, in light of upcoming changes that will embed sustainability considerations into the MiFID II framework. These changes will require firms to consider sustainability preferences as part of the suitability process when providing advisory and portfolio management services. ESMA is considering how it needs to update its Guidelines to reflect these new requirements, in order to assist firms in understanding what is expected of them in an area potentially difficult to navigate given that many clients may have limited understanding of sustainability factors and ESG or sustainability-related products, and that the availability of such products is still reasonably limited.
What information will firms need to collect from clients?
The proposed update to the Guidelines states that firms will need to collect information on clients’ preferences in relation to the different types of sustainable investment products included in the definition of “sustainability preferences” being inserted into MiFID II (which cross-refers to financial instruments with sustainability-related features), and to what extent they want to invest in these products. These preferences then need to be considered as part of the client’s suitability assessment. Firms will need to keep appropriate records of the sustainability preferences of each client (if any), including any updates to these preferences.
ESMA considers that the information to be collected from clients should include all aspects mentioned in the definition of “sustainability preferences” and should be granular enough to allow for a matching of the client’s sustainability preferences with the sustainability-related features of relevant financial instruments. ESMA expects firms to ensure the same level of information is collected on the client’s sustainability preferences when considering a portfolio approach. ESMA also notes that, unlike the other suitability parameters, identifying suitability preferences will require a certain level of self-assessment by the client.
Which clients are affected?
Firms will need to collect and consider sustainability preferences for both retail and professional clients as part of the suitability assessment. These changes to the MiFID II suitability requirements are only being made in the EU and so while they will affect client relationships to which EU MiFID applies, they will not impact client relationships that are governed by the UK MiFID regime.
How should sustainability preferences be taken into account in the suitability assessment?
ESMA emphasises that firms should first assess the suitability of a transaction in accordance with the criteria of knowledge and experience, financial situation, and other investment objectives. Sustainability preferences should then be considered as a second step to ensure that they are treated as an additional element to the suitability assessment, not as a dominating feature.
When will firms need to start gathering information on sustainability preferences?
ESMA proposes that this information can be updated as part of the next regular update of the client’s information, or during the first meeting with the client, after the amendments to the MiFID II suitability requirements take effect.
How should firms help clients understand what is meant by sustainability preferences?
ESMA proposes that firms should be required to help clients understand the concept of sustainability preferences and the different types of investment products included under the definition of sustainability preferences. However, firms also should be careful not to influence clients’ views or perceptions, and need to ensure they adopt a neutral and unbiased approach when providing explanations to clients.
What if a firm does not offer products that match a client’s sustainability preferences?
ESMA considers that firms can still recommend products that do not meet the client’s sustainability preferences, but only after the client has adapted their preferences. However, ESMA also emphasises that clients should not be encouraged to adapt their preferences; firms should only adapt these preferences on a transaction-by-transaction basis and should not apply the change to the client’s profile in general. Any decision to adapt sustainability preferences would need to be properly documented in the suitability report.
ESMA is also conscious that the availability of financial instruments with sustainability features may be limited for the time being, and that the introduction of these financial instruments in firms’ product scope might be gradual. ESMA proposes that firms that do not offer such products would still need to collect all information concerning sustainability preferences from their clients. However, firms would then need to clearly indicate to clients that no products are currently available that would meet those preferences, and the client should be given the possibility to adapt their sustainability preferences. ESMA notes that monitoring situations where there is a significant occurrence of clients adapting their sustainability preferences is important in the transitional stages towards a more sustainable financial system, whereby a wider offer of truly sustainable products will be available.
What else will firms need to consider?
Staff giving investment advice or information about financial instruments will need to have the necessary knowledge and competence with regard to what is meant by sustainability preferences and which products the firm offers that can meet sustainability preferences. They will also need to be able to explain these points to clients in non-technical terms. Therefore, firms will need to provide training to relevant staff members to ensure they have sufficient knowledge of this area.
The consultation closes on 27 April 2022, and ESMA has indicated that it plans to publish a final report in Q3 2022. However, the changes to the suitability requirements under MiFID II will apply from 2 August 2022, possibly causing a delay between the effective dates of the MiFID II changes and the updated Guidelines.
ESMA notes that it plans to publish a separate consultation shortly on amending its Guidelines on MiFID II product governance requirements, to reflect the sustainability-related changes to the MiFID II product governance regime that are due to take effect from 22 November 2022.