MiFID II and Sustainable Preferences

The MiFID II (Markets in Financial Instruments Directive) has undergone a series of amendments. They entered into force on 2 August 2022 and are incorporated into ESG regulation which impacts financial institutions with any form of investment operations. In addition to the obligation to carry out a suitability test, there is also the obligation to request information and report on sustainability preferences.

What is MiFID II?

It is a directive that follows on from MiFID I. It regulates the operation and authorisation requirements for investment firms. It aims to improve the EU’s previous regulation of securities markets. It seeks to achieve this in the following ways:

  • It seeks to make regulated platforms the setting for any organised trading.
  • It includes rules on high frequency and algorithmic trading.
  • It boosts transparency and strengthens supervision of financial markets. This includes derivatives, where it addresses commodity shortages.
  • It boosts investor protection as well as conduct of business rules.
  • It improves the conditions of competition. This is true for both the trading and the settlement phase of financial instruments.

In this respect, the latest amendments focus on two key issues:

  • Investor safety and protection.
  • Sustainability preferences.

ESG investment criteria are also included. These acronyms stand for environmental, social and governance. In other words, they are environmental, social and corporate activity, politics, lobbying or banking and financial practices criteria.

Amendments to the MiFID II regulation

There are a number of updates to the ESG regulation included in MiFID II. They address calls for increased political, social and individual client demand for more sustainable investment. Clients are increasingly looking to manage their finances with sustainability in mind and want to know the environmental risks involved in their investments.

What is changing?

Institutions in this sector report on portfolio management or advisory services to their clients. Until now, before doing so, they had to collect information on, among others, the following issues:

  • Their financial investment objectives.
  • Openness to be exposed to predetermined levels of risk. This allows them to adjust the type of investments recommended to each client.

Additionally, it is now mandatory to collect data and make an assessment of the suitability of investing with a third criterion. This is the sustainability test. In other words, the clients’ sustainability preferences must be considered in order to recommend investments that fit their criteria.

How does it affect investors?

In addition to the suitability test, investors are asked whether they want their investment to follow sustainability criteria. If so, investment managers will need to make investment recommendations that are based on client preferences. They can also choose the PAIs, i.e. the Principal Adverse Impacts, that are taken into consideration.

How is the sustainability of investment funds categorised?

The MiFID ESG Regulation envisages three categories of sustainability for investment products. These, it stipulates, should be an essential part of a client’s sustainability preferences. They are, broadly speaking:

  • Investments with a sustainability component in accordance with Article 3 of the EU Taxonomy Regulation.
  • Investments with a sustainability component as regulated in article 2, point (17) of SFDR or disclosure.
  • Investments that include sustainability factors and take into consideration PAIs according to client-selected quantity and quality factors.

What are sustainability preferences?

Sustainability preferences are the clients’ sustainability priorities for investments in particular financial instruments. When dealing with the client, financial advisors must ask a client for their sustainability preferences and explain the three categories available.

How are they integrated and which products are eligible?

Products that include environmental, governance and social considerations are eligible, however, those that fulfil all three considerations are more likely to be recommended by advisors and brokers.

This type of investment can be managed in many different ways. One is to exclude environmentally harmful financial products. Others focus on investing to limit risk or seeking opportunities by investing in ESG sector leaders.

How can sustainability preferences be recorded in the suitability report?

Sustainability preferences can be indicated by the client directly to their adviser or broker. However, if they do not do so, the adviser or broker is obliged to ask them during the suitability test or report. Inquiries from brokers or advisers regarding sustainable investment objectives should be neutral. This also includes any information provided on ESG finance.

As can be seen from the information above, the MiFID II directive is only one of the regulations that incorporates a comprehensive definition of sustainability, a practice that is increasingly pervasive in all areas of society. If you are looking to promote environmental criteria in your organisation, request a demo of our software.

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