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November 2022

Capturing Sustainability Preferences under MiFID II

The sustainability preferences of clients must be considered when providing investment advice. However, with limited data availability and no methodology defined in the regulation, further regulatory guidance is needed to ensure a consistent market approach.
The EU Action Plan for Financing Sustainable Growth sets out a comprehensive strategy to further connect finance with sustainability. Its key actions include establishing a number of new regulatory measures and amending several existing ones to incorporate sustainability considerations. Some of the most significant recent regulatory updates have been made to the advisory requirements of the Markets in Financial Instruments Directive II (MiFID II).
Integration of the requirements into J. Safra Sarasin’s current approach
Source: Bank J. Safra Sarasin Ltd, as of 30.06.2022

What are the regulatory requirements?

From 2 August 2022, financial institutions must ask their European clients about their sustainability preferences and to what extent they should be incorporated into their portfolio. The resulting sustainability profiles must be considered by client advisors, when determining the suitability of investment advice, alongside their clients’ attitude to risk and their understanding of particular asset classes. Only investments that are aligned with all aspects of the client’s profile may be recommended, unless the client has explicitly consented to deviate from them in order to receive the investment recommendation.

Regulatory challenges

The changes to MiFID II, as well as the EU’s wider sustainability agenda have obvious benefits for addressing environmental and social concerns, and for enhancing investor protection by increasing transparency and reducing greenwashing. There are however, limitations to the current regulatory framework, which are likely to impede its effectiveness.
While the regulation defines the term ‘sustainable investment’, no quantitative criteria or framework are provided to measure it. Each financial institution is therefore able to determine according to their own methodology, whether or not a particular investment is ‘sustainable’. This results in different interpretations across the market in what institutions consider to be a ‘sustainable investment’.
These differences are also driven by a lack of reported data. The amendments to the Non-Financial Reporting Directive and the introduction of the Corporate Sustainability Reporting Directive, which require large European entities to disclose this data in their annual report, come into effect from 2023. However, the regulations that rely upon this information, such as MiFID II, are already in place. Institutions must therefore use proxy data and estimates from third party providers to derive the necessary information, and these sources can often vary significantly.
Consequently, this is likely to cause some confusion to investors in the near term. Further regulatory guidance has recently been published by ESMA (European Securities and Markets Authority), which attempts to standardise implementation. As the regulatory environment evolves, best practices and market standards will emerge.

Bank J. Safra Sarasin’s approach

We believe the current limitations of the regulation are best mitigated by our newly launched Bank J. Safra Sarasin Sustainability Profile, which presents clients with several options that incorporate the sustainable categories to different degrees. Clients with sustainability preferences can choose to concentrate on sustainable investments that consider material environmental and/or social factors in the investment process, or focus only on environmental criteria. Alternatively, clients may select an outcome-focused approach that, on top of incorporating sustainability aspects, also aims to explicitly contribute to one or more of the United Nation’s Sustainable Development Goals. Clients that do not have sustainability preferences can still be recommended investments with sustainable attributes. In all cases, our sustainable investment strategies always seek to manage the potential negative sustainability aspects of investees, also known as “Principal Adverse Impacts”, under the amended regulation.

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