Sustainable finance: no longer a niche sector?

The proposals form part of the Commission’s push to embed environmental, social and governance (ESG) considerations into firms’ investment processes.

Perhaps the most striking proposal is one that would require all AIFMs, EuVECA and EuSEF managers, UCITS managers, individual portfolio managers and investment advisers (amongst others) to publish and maintain written policies on their websites on how they integrate sustainability risks into their investment decision-making processes and / or investment advice.  This requirement would apply to firms across the board, in all asset classes, regardless of whether they actively pursue sustainable investment strategies.

Other transparency measures

These firms would also be required to provide their investors / clients with pre-contractual disclosures that describe:

• the procedures and conditions applied for integrating sustainability risks into investment decisions and/or investment advice;
• the extent to which sustainability risks are expected to have a relevant impact on the returns of the investment(s) in question; and
• how these firms’ remuneration policies are: (i) consistent with the integration of sustainability risks; and (ii) in line, where relevant, with the sustainable investment target of the investment in question.

Additional transparency requirements would apply to a firm that offered its investors / clients a sustainable investment product, such as a fund or managed account.  For example, the firm would be required to publish and maintain, on its website, a description of the product’s sustainable investment target, plus information on the methodologies used to assess, measure and monitor the impact of the sustainable investments selected for the product, including data sources, screening criteria for the underlying assets and the relevant sustainability indicators used to measure the overall sustainable impact of the product.

The Commission’s stated aim with these proposals is to increase disclosure and transparency on a standardised basis, so that investors can more easily compare different firms’ approach to sustainable investment and, the Commission believes, be better informed when making investment decisions.  ESMA, together with the EBA and EIOPA, will be tasked with drawing up regulatory technical standards specifying the content and form of the information to be disclosed.

Other proposals that form part of the package include the establishment of criteria for determining whether an economic activity is environmentally sustainable (the purpose of which is to establish a “common language” for sustainable investment, which can then be applied across the EU for establishing the degree of environmental sustainability of a given investment) as well as the introduction of low-carbon and positive-carbon impact benchmarks.

Suitability

Firms providing MiFID investment advisory and discretionary portfolio management services (so not fund managers such as AIFMs and UCITS management companies) must take reasonable steps to ensure that the personal recommendations they provide and their decisions to trade are suitable for their clients’ needs.  The Commission’s package of proposals include amendments to a MiFID II delegated act¹ which would require such firms to ask their clients about their preferences as regards ESG, and then to take those preferences into account when advising their clients, as part of the product selection process and the suitability assessment.  Indeed, in its Final Report on Guidelines on certain aspects of the MiFID II suitability requirements, also published last month, ESMA acknowledged the Commission’s direction on sustainable finance and recommended as good practice that firms consider ESG factors when gathering information on a client’s investment objectives.  Therefore, to the extent that firms are not already including such non-financial preferences in their suitability assessments, they should begin to introduce them sooner rather than later.

Timing

The proposed amendments to the MiFID II Org Regulation (including those expanding suitability assessments) are open for consultation until 21 June.  Once published in the Official Journal, these amendments will apply after an 18 month transitional period.

The Commission expects the other proposals to be adopted before the European Parliament elections in May 2019, with the bulk of the investor disclosure requirements coming into force after a subsequent 12 month period. 

Comment

ESG considerations have become more widespread over recent years and many corporates are obliged already to report on ESG matters to their shareholders, or do so voluntarily due to market expectations.  Therefore, it is not surprising that the Commission is pushing these proposals forward.  However, following the difficult start to the PRIIPs KID regime earlier this year, firms could be forgiven for wondering whether another standardised disclosure initiative will achieve the intended aim of helping investors/clients with their decision-making. 

For those firms – in particular those managing private funds or managed accounts – that have already negotiated and agreed bespoke ESG frameworks and ESG reporting regimes with their investors, these proposals may represent an additional regulatory compliance burden, without necessarily bringing additional benefits to those investors. 

AIFMs will also want to make sure that any requirement to publish information on their websites – especially fund-specific information – will not prejudice their position under the AIFMD marketing rules. For example, an AIFM would not be want to be precluded from relying on “reverse solicitation” simply because it published information about a fund’s sustainable investment target on its website.  Clarification on this point while the proposals make their way through the European Parliament and the Council would be welcome.

¹The MiFID II Org Regulation (Regulation (EU) 2017/565).