It’s fair to say any announcements to Mifid II will have gone under the radar for most people this year so far. The obviously not-extensive-enough package of legislation is however being updated to include environmental, social and governance, and ‘sustainability’, investment practices, and it expected to come into force next year.
The actual detail is: “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.”
This goes beyond a client preference for ethical and ESG investments. ‘Sustainability risk’ is a new measure added to the regulations and something that advisers need to demonstrate awareness of in relation to the above point.
ESG: Where will we be in five years’ time?
Fortunately, I don’t think this is too hard to incorporate, particularly if you have a well-honed centralised investment proposition and centralised retirement proposition in place.
ESG within your CIP
There are two ways of looking at ESG within your CIP:
- Building a process for advising clients who express preferences for ESG
- Incorporating into and/or supplementing your investment proposition with ESG options
The advice community is fairly well established in working under this first approach, where you consider particular client needs from an investment and work to build an appropriate solution to meet that. As we see with firms when talking CIPs, the process is usually already in place just not documented and detailed in terms of the ‘when, how and what’.
The second option is a bit of a change for some, but it is something we’ve seen develop in a small number of the firms we work with.
Both approaches have, to date, been fairly optional, but Mifid changes will require at least one of these to be present in your CIP.
In addition to the ESG, you will also need to consider sustainability risk. If you are looking to cover your ESG requirements by providing a supplementary investment proposition to your core (non-ESG) options, the new guidelines will require you to assess the sustainability risk of your non-ESG investments.
Sustainability risk is defined by the European regulation as: “An environmental, social or governance event or condition that, if it occurs, could cause an actual or potential material negative impact on the value of the investment.”
Investment managers will have to detail and explain their investment decisions in regards to sustainability risk under disclosures in their prospectus. This requirement comes into force on 10 March 2021 (and so we should expect to see these disclosures prior to this date).
This applies to investment managers who do not pursue ESG strategies and will be the main way in which advisers, as the intermediaries, can judge the sustainability risk of investing in a particular fund or portfolio.
It certainly seems feasible that the FCA will expect advisers to take sustainability risk into account when making personal recommendations. It is unclear at this stage how, or if, sustainability risk will be quantified on a fund factsheet.
When is it coming?
This is likely to be introduced in two phases, the first being the requirement for investment managers to publish detail on sustainability risk in their investments by 10 March 2021. The requirements for advisers to have knowledge and processes for ESG investments is likely to follow, though no specific date is provided as of yet.
ESG funds and investment strategies are increasingly gaining traction in the advised and non-advised investment space, as indeed more and more people are considering environmental and social issues outside their finances. It’s worth starting to review your processes now to take account of this, before it becomes enforceable and who knows, you might also attract new, ESG-minded clientele.
Jo Campbell is director of operations at Para-Sols