MiFID II and Sustainable Preferences

The Markets in Financial Instruments Directive, or MiFID II, represents a fundamental pillar in European financial regulation, redefining investment practices and the protection of investors in a post-crisis environment.

This article will explore the regular updates and how they influence sustainability preferences within the financial sector.

Through ESMA guidelines, we will delve into the MiFID II’s commitment to transparency, the adaptation of financial products and corporate responsibility, offering a more robust framework for financial investors and entities in the global context that’s more and more conscious of the environmental and social impact of investments.

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What is MiFID II?

MiFID II is a European Union Directive that regulates investment service companies and financial market instruments.

It establishes stricter requirements in the field of conduct and it clearly communicates the responsibilities of financial entities to ensure they act with their clients best interests.

Objectives of the Directive

The Directive MiFID II defined the norms that negotiation platforms, investment companies and intermediaries should follow to facilitate more transparent and fair transactions.

The focus is on the protection of the investor, the betterment of the market quality and the introduction of sustainability tests for investment, including the consideration of sustainability factors.

At the same time, it considers ESG criteria in investment. The acronym ESG refers to environmental, social & governance criteria.

Origin and evolution of MiFID II

MiFID II is the revision of the original Markets and Financial Instruments Directive (MiFID), implemented in 2007. The update reflects lessons learnt during the financial crisis of 2008, proposing a stricter and wider regulatory framework.

With its implementation in January 2018, it brought significant changes to the infrastructure of the European financial markets and to the way in which investment companies operate and manage risks.

What is Green MiFID

The term “Green MiFID” refers to introduced modifications in the MiFID II which incorporates sustainability considerations within financial advising and investment decision making.

These amendments are a part of the European Union’s action plan to finance sustainable growth, ensuring that clients’ sustainability preferences are taken into account throughout the advising process and that financial products which are offered comply with certain ESG criteria.

Guidelines with regards to the evaluation and convenience of MiFID II

The European Securities and Markets Authority (ESMA) provides detailed guidelines to guarantee that investment service companies adhere to the principles of the MiFID II, with the particular focus on the evaluation and convenience of the execution of financial operations.

Customer Information and Convenience Assessment

ESMA guidelines establish a necessity for companies to provide accessible and relevant information with regards to services offered, ensuring that clients understand the purpose of the convenience assessment.

This assessment is crucial to determine whether or not a client has the necessary experience and knowledge to understand the associated risks with certain products and investments, and whether or not these products are suitable for them.

Knowledge of the Product and Client

The ESMA also underlines the importance of a company’s understanding of the background of the products they are offering and to whom they are offering them.

Investment firms should implement procedures and policies that allow them to compile detailed information about their clients’ investment experience and objectives.

This ensures that recommended investment products align with the clients’ necessities and risk profile, complying in such a way with the investor protection standards established by the MiFID II.

MiFID II compliance according to ESMA

The ESMA establishes a framework to ensure financial entities strictly adhere to MiFID II mandates, promoting market integrity and protecting investors.

Compliance and Information Obligations

Companies must comply with a set of information and transparency obligations to meet the MiFID II. These information and transparency obligations under MiFID II include:

Transaction Reports: companies must report details of all transactions derived from financial instruments to competent national authorities.
Pre and Post-Trade Transparency: They should publish information about prices, costs and charges both before and after the operations are carried out.
Suitability and Convenience Assessments: It is necessary to carry out assessments to ensure that offered products adapt to the profile of each client.
Product Governance: Companies must have processes to design, commercialise and review financial products, ensuring they are driven towards specific markets.
Business Conduct and Conflicts of Interest: They should act honestly and with their clients best interests, managing adequately conflicts of interest.
Recording Communications: Communications related to transactions should be recorded and stored.
Information regarding Expenses and Charges: Provide clients with clear information regarding expenses and charges associated with investment services and financial products.

Categorisation and Reliability of Client Information

The ESMA demands that firms appropriately classify clients based on their knowledge and experience to determine the convenience of sustainability products.

Companies must have procedures to ensure that client information is up to date, precise and reliably reflects their circumstances, guaranteeing their validity and evaluating convenience.

Now, furthermore, it’s obligatory to gather data and evaluate the convenience of investment with a third criterion. This is the sustainability test. That is to say, it’s necessary to know preferences in this aspect to recommend investments accordingly.

Investors must be asked if they want their investment to follow sustainability criteria. If so, the distributors will have to formulate investment recommendations that are grounded in the clients preferences. Likewise, they can choose the elements that show they have PAI considered, that is to say, the principal adverse impacts.

How the sustainability of investment funds is categorised

The ESG MiFID II ruling considers, for investment products, three sustainability categories. These, as postulated, must be an essential part of a clients’ sustainability preferences. They are broadly speaking:

Investments partially dedicated to sustainability in accordance with article 3 of the EU Taxonomy Ruling.
Investments partially dedicated to sustainability in accordance with article 2, point (17), SFDR or disclosure.
Investments that include sustainability factors considering PAI according to quantity and quality factors chosen by the client themselves.

Categorising investments in this way, MiFID II promotes better transparency and allows investors to make more informed decisions, forming in such a way the long term integration of sustainable practices in financial strategies.

What are sustainability preferences

They are a clients’ investment priorities in certain financial instruments. When the financial consultant deals with a client they should ask them if they have sustainability preferences. Furthermore they should explain the three eligible categories from which to choose.

How they are integrated and what products are eligible

Those eligible include environmental, social and governance considerations. The products that align with the three segments are better positioned to be recommended by consultants.

This type of investment can be managed in different ways. One of which excludes financial products harmful for the environment. Others focus on investing to limit risk or look for opportunities investing in ESG leading industries.

How can you register sustainability preferences in a suitability report

Sustainability preferences can be indicated by a client directly to their consultant or agent. Nonetheless, if this isn’t done, they have the obligation to ask you during the suitability test or sustainability report. They must ask, in a neutral manner, about your sustainable investment objectives. This includes detailing information about ESG finance.

As can be seen, the MiFID II is only one of the norms that includes sustainability transversely. This criteria is more and more present in all sustainability environments.

MiFID II Conclusion and Future

MiFID II has transformed transparency and protection in the financial services environment within the EU. Its regulations have established a new standard in the evaluation and disclosure of risks, looking to guarantee that investors are completely informed and protected.

Preparation for MiFID III and Sustainability Trends

Anticipating MiFID III, companies can start to adapt to the next sustainability trends.

It’s hoped that MiFID III deepens ESG considerations, extending responsibilities for companies to include sustainability as a key factor in financial assessment. This can include the integration of ESG criterias in all the stages of the assessment and investment process, guaranteeing that sustainability is a pillar within financial strategy long term.

With the market in constant evolution and growing demand for sustainable investments, preparing yourself for these changes is an essential part of survival and success in the financial sector.

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