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Rules on mandatory ESG integration proposed for advice

The European Commission has published draft rules on how to incorporate environmental, social and governance preferences into investment advice.

The proposed regulations seeks to make integration of clients’ ESG preferences mandatory for those providing investment advice.

The European Commission first revealed its intention to make it mandatory to inquire about the clients ESG preferences in March 2018 with its Action Plan on Financing Sustainable Finance.

It proposes to do so by amending  MiFID II and the Insurance Distribution Directive to ensure sustainability preferences are taken into account in the suitability assessment.

Current MiFID rules on suitability require financial professionals to obtain information about client’s  knowledge about investments and assess their risk profile in order to recommend products suitable to the client. Non-financial objectives are left out, however.

The European Commission has found that the existing suitability assessments usually do not include ESG issues, and the majority of clients did not raise these issues themselves. This means the firms do not consistently factor in ESG issues in their process.

The proposed changes aim to unify integration of ESG considerations into the investment and advisory process “in a consistent manner across sectors.” The requirements to integrate ESG into their internal processes and to inform their clients about it would apply to asset managers, insurance companies, pension funds, or financial advisers, providing investment advice.

Apart from amending suitability rules, the draft also proposes new categories of low carbon and positive carbon impact benchmarks.

The proposals are part of EU’s efforts to align European policy framework and investing with the UN’s 2030 Sustainable Development Goals.

In January 2018, the European Commission’s EU High-Level Group on Sustainable Finance recommended agreeing a taxonomy on sustainable finance at the EU level. That agreement must be reached in order for the draft rules on ESG to be adopted.

The rules will then enter in to force after being published in the Official Journal of the European Union and only if they do not come up against objections from the European Parliament or European Council.

Changes to legislation

  • The European Commission states the goal of the legislation:

“To enable investment firms that provide investment advice and portfolio management to recommend suitable products to their clients, those investment firms should introduce in their suitability assessment questions that help identify the client’s individual ESG preferences.

“In accordance with their obligation to act in the best interests of the client, recommendations to clients should reflect both the financial objectives and, where relevant, the ESG preferences expressed by those clients.”

  • It proposes introducing a definition of ESG preferences:

“ESG preferences’ means a client’s or potential client’s choice as to whether and which environmentally sustainable investments, social investments or good governance investments should be integrated into his or her investment strategy.”

  • The European Commission also proposes firms should be able to demonstrate how they include ESG when assessing suitability:

“Investment firms shall have in place, and be able to demonstrate, that they have in place adequate policies and procedures to ensure that they understand the nature, features, including costs, risks of investment services, and financial instruments selected for their clients, including ESG considerations where relevant, and that they shall assess, while taking into account cost and complexity, whether equivalent investment services or financial instruments can meet their client’s profile.”

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