One question just isn’t enough when it comes to an effective – and compliant – way of dealing with ESG & Sustainability within the financial planning process. ESG Accord’s Lee Coates OBE suggests some practical ways in which advisers can not only improve the client experience when it comes to ESG & Sustainability, but ensure a more robust compliance approach too.
What question am I referring to? Well, it’s the ‘ESG’ question. We are finding more and more advisers embracing the idea of building environmental, social, governance and sustainable factors into their financial planning process, which is fantastic. However, far too many are tackling the issue with a single or limited questions.
The problem for good client outcomes is the phrase “We ask the question”. It should be plural rather than singular; “We ask the questions as part of our KYC”.
By asking a single question such as “Do you want ESG?” or “Do you want ethical investment?” there is a complete reliance on the client understanding what is being asked. Without suitable information being provided well in advance of the question, there is a high compliance risk that the client might just provide an easy answer (which is usually No – see later for how to deal with a No answer).
An informed decision?
Now, where a No answer is appropriate, that’s fine. But what information is being recorded on the client’s file to demonstrate that the client understood the question and, as a result, was able to provide an appropriate answer? If a complaint arises in the future, the advice firm may find it difficult to demonstrate that the client was making an informed decision.
Looked at another way, asking the ESG/Ethical question without any explanatory information is equivalent to asking a client “On a scale of 1-5 where do you stand on Investment Risk and Capacity for Loss?” and refusing to provide any information about what this means, equity risks, loss tolerances etc.
No good compliance process would allow this approach because no client could be expected to express their attitude to risk and capacity for loss without understanding what it means. The same applies to asking ESG/Sustainable/Ethical questions.
The singular v plural issue
The essential problem with a single question is that it removes client choice and assumes that a client’s values are directly linked to the question. A client may want to invest in line with their faith or, if asked, might prefer to invest in line with the UN’s Sustainable Development Goals (SDGs). By default, therefore, any answer to a single question chosen by the adviser is going to be wrong. It is not the client’s fault that they were not asked appropriate questions by their adviser. Once again, how could this be a compliant file and, as such, how would the adviser defend a potential future complaint?
Advice processes need to adapt to the dramatic increase in sustainable preference choices and move away from asking a single question. We recommend a short Triage process, with corresponding educational material. The information ensures the client is informed about the choices available and the Triage process allows the adviser to follow the existing PROD/MIFID II rules in respect of Target Markets assessment. If the client expresses deeper interest or opinions these will be picked up in the Triage questions and our more detailed Values Questionnaire can be used to gather these additional client specific details.
A question of detail
Finally, let’s look at what happens if a client answer No to an ESG question. This is easy; record it on file and confirm in the Reason Why Letter. However, is that really all there is? Let’s look at what the client has just said No to. ESG isn’t a single ‘thing’. It has three quite distinct parts; Environmental, Social and Governance. A No answer confirms that the client does not want any of these three parts included in the financial advice process. But that’s surely a problem for the ‘G’ part – how easy would it be to find a fund with no governance?
The adviser should not assume that this problem is obvious to the client and that when the client has said No to ESG they didn’t mean No to G. All advisers should provide information to the client to confirm this discrepancy and to obtain, in writing, confirmation from the client that it is only the E and S parts of ESG that they do not want included in their investment strategy. This can be followed up in the Reason Why Letter.
About ESG Accord
ESG Accord provides template compliance framework to firms so they can develop appropriate compliance process to handle ESG and Sustainability preferences. We provide educational material to help adviser clients make informed decisions and give firms the documentation needed to process client responses. Contact us for more information: firstname.lastname@example.org
About Lee Coates OBE
Lee spent 31 years running his own financial advice business (Ethical Investors), dealing exclusively in ethical and responsible investment advice. In 1998 he established an independent ethical research company (Ethical Screening) and in 2010 launched Australia’s first animal-friendly Superannuation fund (Cruelty Free Super). In 2011 he was awarded an OBE for ‘services to ethical business and finance’. In October 2020 he launched ESG Accord, an adviser support business assisting firms to implement suitable compliance procedures to meet sustainability preferences requirements