- This week an amendment to EU investor protection framework Mifid II comes into force that will require financial advisers to consult investors on their sustainability preferences.
- Distributors say this is common sense as it reflects clients’ needs and expectations, but implementation has faced challenges.
- A lack of both guidance and data could further raise mis-selling and greenwashing risks and thereby damage investors’ confidence in ESG funds.
The average retail investor’s understanding of a sustainable investment varies wildly. But from 2 August, individuals must be consulted on their ‘sustainability preferences’ when being sold financial products in Europe.
This is a long-awaited change to the EU’s Markets in Financial Instruments Directive (Mifid II), a far-reaching investor protection framework that has been in place since January 2018. Amending the regulation along these lines makes sense, say fund advisers and distributors, as the topic of sustainability comes up in conversations with most clients now.
But it also requires considerable training for sales staff. If this is not done properly, it could spark risks of mis-selling or greenwashing, thereby potentially damaging confidence in sustainable investing at a time when it is already experiencing a backlash from some quarters. The fact that implementation guidance is still lacking for Mifid II, combined with sequencing issues for related regulation such as the EU taxonomy, further heightens this risk.
“The funds industry as a whole is very happy that we are starting to talk about incorporating customers’ sustainability preferences – it will be extremely beneficial, and we see many opportunities,” says Carolina De Giorgi, regulatory policy adviser at the European Fund and Asset Management Association (Efama) in Brussels. “There is a clear trend towards clients wanting their money to do some good and to have an impact.”
That sentiment has translated into swift market growth. Assets in sustainable funds (as per research house Morningstar’s definition of such products) had hit €2.47trn on 31 March, up from almost €2trn at the end of 2021, with 82% of those assets domiciled in Europe, according to the Association of the Luxembourg Fund Industry.
Mifid II guidance lacking
However, Mifid II implementation has not been a smooth ride. First it was delayed from early 2021 to August this year. And even as the directive’s requirements come into force this week, regulators are yet to release the final guidelines, leaving the specifics of implementation open to interpretation.
As Capital Monitor reported last year, some worry that forcing client-facing executives to advise on sustainability issues would go against Mifid II’s core objective – protecting investors – by encouraging inexperienced staff to consult on issues they do not understand, a phenomenon referred to as ‘competence greenwashing’.
Financial product distributors say they have been providing extensive ESG-related training for client-facing staff for some time now, as a response to both regulatory requirements and client demand.
Spain’s CaixaBank has been providing ESG training for its 30,000 staff that offer advice and commercial services ahead of the regulatory change, says Carlos Barrientos, sustainability strategy and reporting manager at CaixaBank.
The firm has also developed a Q&A about how to incorporate questions that can help determine clients’ sustainability preferences, such as when to add ESG preferences, when these can be changed, what kinds of tests are affected, how to formulate the new questions and how to help the client understand the changes, says Guillermo Hermida, investment and sustainability strategy manager at CaixaBank Private Banking.
But the process of training staff and educating clients has been made more difficult by the lack of standardisation across the industry. Product distributors have largely been left to decide on their own how to communicate sustainability concepts, which could lead to confusion.
Issues with regulatory sequencing
In addition to the lack of guidance, there are also sequencing issues. The Mifid amendment references various other pieces of EU regulation, including the taxonomy of sustainable activities and the EU’S Sustainable Finance Disclosure Regulation (SFDR). Even though these frameworks overlap in myriad ways, elements of taxonomy reporting will not be fully implemented until next January, and SFDR will not be fully in place until June 2023. Reporting against these regulations so far has, accordingly, been inconsistent and confused, say trade associations and fund managers.
The issue is that the Mifid suitability assessment is based on a so-called European ESG template (EET), for which asset managers began submitting data on 1 June. The regulatory sequencing issue has resulted in major data gaps, even in information that has been reported, says Morningstar in a 28 July report that analysed EET data on some 70,000 share classes of funds (see chart below). It concluded that advisers would struggle to find suitable products, due to “patchy data and a lack of direct comparability between products, driven by the different approaches that asset managers are taking”.
Responding to the regulator’s consultation in April, the Association for Financial Markets in Europe flagged this issue. It argued that retail investors “may be asked seemingly redundant questions or presented with an overload of complex information and documentation, [which] they may find difficult to navigate”.
Like Morningstar, De Giorgi is concerned that this will make it hard for advisers to meet investors’ sustainability needs, because they don’t have the guidance or the data.
“We fear a big mismatch between the high expectations clients have and the current market reality,” she adds. “Our members are very worried about this – we’re making this change to provide the best possible experience for the investor, and we don’t want to confuse or frustrate them. It’s important to keep the customer engaged in the process.”
Implications of Mifid II change beyond the EU
Even firms not directly affected by the legislation acknowledge it will have implications for them.
The change under Mifid II “certainly adds to the confusion, particularly for asset managers”, says Emma Wall, head of investment analysis and research at UK fund distribution platform Hargreaves Lansdown.
Wall says that while the company, which has £136bn of assets under management, is not regulated in the EU and does not officially have to make the change, it is common sense to do so. Hargreaves Lansdown began consulting clients on their sustainability preferences in early 2021.
It also did so in anticipation of an upcoming change under the Sustainability Disclosure Requirements (SDR), the UK’s answer to SFDR – though information on this regime is also lacking.
While interest levels vary, most clients want some form of ESG integration as a base case, Wall says. “Some are looking for exclusions, but I’d say that’s a minority. The majority would like ESG considerations as part of ongoing risk management.”
It is entirely possible that the challenges posed to the funds industry by Mifid II do not affect consumers’ overall experience. But if mis-selling were to occur, investor confidence in sustainable investing as a whole is likely to take a further hit, particularly given the often high-profile nature of cases such as the DWS scandal and the growing number of critics of ESG.
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