What rule changes should advisers be preparing for?

While UK regulation on ESG investing may not yet be changing, there is much for advisers to be thinking about, writes Tom Higgins…

With environmental, social and governance (ESG) issues becoming increasingly prevalent across the financial sector, ensuring that advisers are able to offer the best advice and guidance on these matters is imperative.

On top of the qualitative attributes that clients and investors are increasingly seeking, a shift in sustainability regulation is expected. Although not imminent, it will drive the shift towards ESG investing even further, making the present moment a good opportunity to get on top of how to implement its due diligence – something many advisers are doing.

Comprehensive due diligence processes are an integral part of an adviser’s role, through frameworks such as PROD, yet ambiguity exists within the environmental legislative consequences of Brexit, and the timeline for the implementation of sustainability regulation, parallel to that drafted in Europe.

Yet implementing the ESG wishes of a client has become normalised, preceding legislation, and begins at the outset of the relationship between client and adviser.

“Advisers need to ensure that they are able to focus on the non-monetary side of investments,” says Michael Cotter, financial services and litigation lawyer at Setfords solicitors. “This is a complete shift from the traditional take of investing purely for financial reasons.

“Advisers already met with a barrage of regulation will now have to ensure that products are catered specifically to the needs and wants of investors who wish to invest for socio and political reasons.”

This is something that Helen Lupton, compliance director at True Bearing, also acknowledges, but she has identified the benefits of outlining an individual’s ideals when applying the necessary legislative measures.

“The more an adviser understands an individual’s requirements, the easier it is to make an appropriate recommendation, fulfil the MiFID II requirements, and outline how the features of a particular offering match the needs of the client,” she says.

Wider ideals

Yet these discussions need to go further than the initial fact find, Lupton says, and beyond being driven by legislative necessity. They should encompass the ideals and outcomes that a client hopes to achieve.

“I believe that every adviser should be talking to their clients about ESG and ethical investing and I would welcome it becoming a mandatory area of discussion,” she adds.

But soon enough, the legislative demands will catch up to the wants of the client and embedding ESG elements will become increasingly vital and prevalent, although the exact timeline for when this will be implemented, and indeed the contents of any measures, are yet to be known.

Mikkel Bates, regulatory manager at FE fundinfo, says it is likely the FCA or Treasury will enact measures to drive funds and advisers down the ESG route, although there is “nothing officially in the pipeline”.

“Technically, there is no change coming for advisers as the UK is not implementing SFDR on March 10, or at all, but the UK is committed to ‘matching the ambition’ of the EU’s sustainable investment reporting requirements and will instigate TCFD-aligned reporting requirements over the next five years, which are purely climate-related, not wider ESG.

“It also applies to investee companies, occupational pension schemes and asset management groups, rather than advisers,” he adds.

European developments

Alongside UK legislation, Bates emphasises the need to keep an eye on developments within Europe, the current hotbed for ESG investing, as any rulings passed there will have implications for the wider market and may act as a catalyst or model for any future UK proposals.

“Proposed changes to MiFID II need to potentially be considered, although they have not yet been made law in the EU and won’t take effect until a year after the law is passed,” Bates explains.  

This legislation will not automatically apply in the UK, but it may require MiFID-accountable firms, typically advisers and discretionary managers, to factor ESG into their suitability considerations.

One area of concern to legal expert Cotter is how advisers will be able to remain compliant as regulations surrounding the non-financial factors of an investment amplify.

“It is anticipated this is merely the first wave of regulations regarding ESG and advisers will need to ensure compliance from the outset and prepare for stricter regulation,” he says.

“It is likely the manner in which the Financial Ombudsman Service reviews claims will change, with investors being able to claim against firms concerning their investments but for non-monetary reasons. Hence, performance will no longer be a potential initial indicator, rather suitability based up on the ethical and sustainable nature of investments, and this gives rise to the obvious headache of how loss is quantified.”

Navigate the challenges

Current PROD guidance includes various measures on governance and due diligence, but Bates says that “there is no guarantee that the FCA will make changes to PROD to incorporate future changes” regarding wider environmental and sustainability criteria.

But knowing what to expect to maintain due diligence in an unpredictable legislative landscape is not straightforward.

That is why Seetal Modi, specialist financial lawyer at Fladgate, recommends the industry take note of what is currently drafted in the EU, but to take with a pinch of salt how it will be implemented in the UK.

Her recommendations for a practical response include enhanced ‘know your customer’ processes; the expectation of new senior management roles responsible for sustainability risk; a shift towards long term success measures; improved training to ensure commitment to sustainability risks; as well as investment into public relations projects.

By preparing with these measures in mind, advisers should be able to navigate the changing times ahead.

Sustainable Investment Festival, 22-24 June 

Professional Adviser’s parent company Incisive Media will host its inaugural Sustainable Investment Festival this summer, featuring keynote speakers, innovative breakout events and sessions to help investors navigate this rapidly-evolving area of the market. Click here for more information.



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