While researching this report, there seemed to be a lot of providers who were majoring on their ESG credentials. I found that this is in preparation for the implementation of MiFID II regulation relating to the adoption of ESG investment principles. The EU Regulation on sustainability-related disclosures in the financial services sector came into force at the end of December 2019 and will apply 15 months later. It is yet another indicator that ESG matters are growing in importance as a compliance issue for financial institutions.
There are some providers who are closely following this and revolving their whole investment strategy around ESG. At the other end of the scale, I suspect some providers are labelling funds as ESG, but being little more than a tick-box exercise or greenwashing a portfolio to fulfil their obligations.
ESG investing takes into account ethical factors alongside financial markers in the decision-making process and has become more commonplace in the global investment space in recent years.
But greenwashing — a phenomenon of growing concern in the financial sector, which sees firms market products and investments as more sustainable and ethical than they really are — has been a thorn in the side of the responsible investment movement.
MiFID II’s sustainable finance measures mean firms must explain what happens if clients say yes to interest in ethical investing.
IFAs who have resisted ESG investing will now have to start taking ESG into consideration. And if IFAs fail to take heed of the proposed sustainable regulations when they go through next year, they could have to answer to the FCA.
Last year the European Commission, in conjunction with the European Securities and Markets Authority, proposed changes to MiFID II to bring financial advice firms into line with the EU’s climate action plan through the integration of sustainability and ESG considerations. Assuming that Britain’s financial regulation remains aligned with the EU’s in the aftermath of Brexit, these changes could have a big impact on UK IFAs.
Dated 27 November 2019, EU parliamentary regulations stated advisers should “take sustainability risks into account in the selection process of the financial product presented to investors before providing advice, regardless of the sustainability preferences of the investors”.
That means joining the dots between suitability and sustainability, regardless of whether the client has expressed any preference towards ESG investing.
Additional transparency clauses in the EU’s report explained what advisers must include in their due diligence. These included the extent to which sustainability risks are integrated into investment decisions and an assessment of the likely impacts of sustainability risk on client returns.
“Where advisers deem sustainability risks not to be relevant, the descriptions referred to in the first subparagraph shall include a clear and concise explanation of the reasons,” it said.
When a client shows interest in ESG, an IFA must have the knowledge and policies to ensure their clients receive suitable advice. A firm’s advice process will need to show how ESG funds are identified and how the IFA assesses one against another to ensure they can put together the appropriate products and funds to meet each client’s needs.