New Sustainability Requirements for Investment Services
As a result of the EU’s Action Plan on Sustainable Finance and the objective to reorient capital flows towards sustainable investments, the MiFID II framework has recently been updated.
The new rules integrate sustainability factors, sustainability risk and sustainability preferences into the organisational requirements and operating conditions of investment firms, credit institutions, investment advisers and portfolio managers[1]. They also require the consideration of sustainability factors and sustainability related objectives within the product governance process.
Sustainability aspects in the organisational and operational requirements
Amendments have been made to the MiFID II framework through the Delegated Regulation (EU) 2021/1253, introducing the requirements on sustainability factors, risks and preferences to be considered in the organisational set up and operations of concerned entities. In accordance with the new requirements in the Delegated Regulation, investment firms, credit institutions and other investment advisers and portfolio managers shall:
- Take into account sustainability risks when satisfying the general organisational requirements on aspects such as decision-making procedures, organisational structure, allocation of responsibilities, internal control, internal reporting and knowledge and expertise of the personnel.
- Consider sustainability risks in risk management policies and procedures when identifying risks relating to activities, processes and systems, and when setting the level of tolerated risk.
- Include client’s sustainability preferences when identifying conflicts of interest that may arise when providing services and whose existence may damage interests of a client.
- Collect information from clients to ensure a reasonable basis for determining that the investment advice or portfolio management service meet the client’s objectives and profile, including any sustainability preferences.
- When providing investment advice share a description of the sustainability factors taken into consideration when selecting financial instruments.
- In the suitability report to retail clients that outlines the investment advice, include how the recommendation provided meets the client’s sustainability preferences.
ESMA has published revised guidelines on certain aspects of the MiFID II suitability requirements on the topic of sustainability partly based on the alterations made in the Delegated Regulation (EU) 2021/1253. In accordance with the revised guidelines, investment advisers and portfolio managers should:
- Support clients in understanding the concept of sustainability preferences and explain different products and collect information from clients in an unbiased way.
- Only address sustainability preferences once suitable products in accordance with the criteria of knowledge, experience, financial situation, and other investment objectives have been identified.
- Have procedures for appropriate record keeping of the sustainability preferences of the client (if any) and of any updates of these preferences.
- Provide relevant staff members involved in suitability assessments with training on sustainability.
To conclude, investment firms, credit institutions and other investment advisers and portfolio managers will need to review and adapt their organisational structure, internal control and risk management to ensure that sustainability risks are considered. Additionally, procedures for identifying conflicts of interest must include clients’ sustainability preferences. Affected companies will also need to adapt suitability assessments and reports, update internal rules and information to clients to enable them to consider sustainability preferences.
The amended Delegated Regulation (EU) 2021/1253 entered into force on August 2nd, 2022. ESMA’s revised guidelines will apply six months from the publication of translated guidelines and national authorities will then notify if and how they intend to comply with these.
Sustainability aspects in the product governance requirements
The Delegated Directive (EU) 2017/593 supplementing MiFID II has been amended to integrate sustainability factors in the product governance process. In accordance with the new requirements, investment firms, credit institutions and other investment advisers and portfolio managers shall:
- Consider any sustainability related objectives when identifying the potential target market and specifying the type(s) of clients each financial instrument is compatible with.
- Not consider sustainability factors when identifying the negative target market.
- When assessing the needs, characteristics and objectives of the target market, also determine if any sustainability related factor is consistent with the target market of the financial instrument.
- When manufacturing financial instruments, present the instrument’s sustainability factors in a transparent manner and provide distributors with the information for them to take due account of a customer’s potential sustainability related objectives.
- When reviewing financial instruments manufactured or distributed, consider whether the financial instruments or service provided remains consistent with any sustainability related objectives of the identified target market.
To conclude; investment firms, credit institutions and other investment advisers and portfolio managers will need to review and adapt their product governance arrangements for financial instrument to ensure that any sustainability related objectives are considered. A key feature of the requirements is to specify, where applicable, the type(s) of clients with sustainability related objectives the financial instrument is supposed to be distributed to.
The Delegated Directive (EU) 2021/1269 regarding the integration of sustainability factors into the product governance requirements entered into force on November 22nd, 2022. In Sweden, this has been implemented into national legislation through amendments to Finansinspektionen’s (the Swedish financial supervisory authority) Regulations regarding investment services and activities (FFFS 2017:2).
Expectations from the financial supervisory authority
Finansinspektionen has acknowledged the challenges that exist with the implementation of the new sustainability requirements due to, among other things, the interpretation of the regulations and the access to reliable and comparable sustainability data. The authority nevertheless expects affected companies to work actively with the implementation of the regulations and adopt their operations as they come into force and further guidance becomes available.
FCG can offer investment firms, credit institutions and other investment advisers and portfolio managers an efficient and thorough review of the compliance with the new sustainability requirements and, if necessary, recommend appropriate actions to take and support the practical implementation in the business. FCG has extensive experience of working with compliance and internal governance and control, providing a holistic view when assessing and implementing regulatory requirements across the organisation.
[1] Such as investment firms, credit institutions providing investment services, fund management companies and alternative investment fund managers providing investment advice and/or portfolio management.
