The key points of the proposed MiFID II rules changes
- Suitability assessments will need to incorporate clients’ sustainability preferences.
- From 2021, advisers will need to explain their approaches to sustainability risks in client terms and on websites.
- The Investment Association’s Responsible Investment Framework is a step towards industry consensus on the meaning of terms such as ESG
- The Investment Association is looking to develop a UK eco-label for funds.
Sustainable investing and environmental, social, and governance (ESG) have become buzzwords in the financial services industry, barely a week passing without a mention of these themes in the trade and mainstream press. A plethora of new industry bodies and initiatives have sprung up, both in the European Union (EU) and globally, with new regulations emerging as the EU Commission seeks to reorient private capital flows towards sustainable investments to help meet its ambitious climate and energy targets. Advisers should be aware that these EU regulations will land in 2021 and 2022, and, with the UK government stating its ambition to be a leader in this space, it seems likely that UK firms will have to comply with most, if not all, of the new requirements.
This article aims to update you on the more significant of these recent developments.
Before getting into the weeds on EU regulation though, advisers should be aware of the good work being done by the UK Investment Association (IA). In November 2019, the IA published its Responsible Investment Framework in an attempt to reach industry consensus on the meaning of terms such as ESG and Impact. We would urge all advisers to read the IA’s report, available on its website, as it contains useful graphics and a glossary explaining the language that fund managers will now be using when describing the sustainable and responsible investment approaches of their funds.
Looking forwards, the IA has now set up a working group, of which Charles Stanley is a member, to consider the creation of a UK eco-fund label with an intended launch date in late 2020 or early 2021.
Turning to the incoming regulations, the EU is proposing to alter the MiFID II rules on Suitability to require the consideration of clients’ sustainability preferences when undertaking a Suitability assessment. The EU Commission’s latest consultation on this requirement – including the meaning of sustainability preferences - closed at the beginning of July, but as presently drafted it would oblige advisers to ask whether a client would like what is now being called an Article 8 or an Article 9 fund included in his or her investment strategy.
The Commission has suggested there may be no need to repaper existing clients to collect their preferences, but we have asked the Commission for formal confirmation on this point.
What the Commission has confirmed already though is that the Suitability assessment will be a two-step process. First, advisers must follow their current processes for arriving at an understanding of the client’s objectives and risk profile, and only then, once this has been established, should they factor in any sustainability preferences. This is necessary for avoiding any adverse consequences that might arise in the event that a client’s sustainability preferences clash with their ‘ordinary’ suitability requirements; in the event this occurs, the latter has priority, meaning that clients will not need to take on more risk than would otherwise be suitable for them, just to satisfy a sustainability preference.
There will be a twelve-month implementation period following the publication of the final rules, which we believe means a go-live date of Q1 2022, or Q4 2021 at the earliest.
Advisers should be aware that there is another EU regulation: The Sustainable Finance Disclosure Regulation (SFDR, or in EU-speak 2019/0179). This has already been passed and comes into effect from March 2021, although some provisions will impact at the end of 2021. It will apply to investment firms that provide advisory services, subject to an exemption for advisers that employ less than three persons.
The SFDR introduces the concept of an Article 8 or an Article 9 fund mentioned previously. In brief, an Article 9 fund is a ‘sustainable investment fund’, an Article 8 fund one that ‘promotes environmental or social characteristics’. The former is tightly defined by the regulation and requires close alignment with the EU Taxonomy, which defines what the EU considers to be ‘dark green’. The scope of the latter is not yet wholly clear and we are working with the trade associations and the FCA to better understand it; as one would expect with any EU regulation, it does not necessarily fit well with the terminology we are used to in the UK.
As its name suggests, the SFDR will require a significant level of additional client disclosure from advisers, including (and I quote verbatim):
- Advisers shall publish on their websites information about their policies on the integration of sustainability risks in their investment advice or insurance advice.
- Advisers shall publish and maintain on their websites: (a) information as to whether, taking due account of their size, the nature and scale of their activities and the types of financial products they advise on, they consider in their investment advice or insurance advice the principal adverse impacts on sustainability factors; or (b) information as to why they do not consider adverse impacts of investment decisions on sustainability factors in their investment advice or insurance advice, and, where relevant, including information as to whether and when they intend to consider such adverse impacts.
- Advisers shall include descriptions of the following in pre-contractual disclosures: (a) the manner in which sustainability risks are integrated into their investment or insurance advice; and (b) the result of the assessment of the likely impacts of sustainability risks on the returns of the financial products they advise on.
There is currently an open EU consultation (closing October) proposing the detailed expectations for the content and presentation of the above information. We expect to have this confirmed in January 2021.
Discretionary investment managers such as Charles Stanley will face similar, if not greater, disclosure requirements – and we are tracking this topic very closely.
Trade associations are currently liaising with the Treasury and the FCA on the likely content and timing of the UK adoption of these changes, which would be subject to prior industry consultation. The Chancellor has indicated that the UK may start to diverge from the EU in respect of incoming EU regulations, but until a deviation is confirmed it would be prudent to plan for full implementation. Charles Stanley is an active member of the UK Investment Association and The Savings and Investment Association (TISA), sitting on the relevant committees looking at this issue, and we have regular meetings with the FCA and other policymakers. We will bring you further news on developments in this space, as and when they occur.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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