ESG preferences and advice suitability – time to prepare?

ESG preferences and advice suitability – time to prepare?

In the not-too-distant past, ESG and sustainability were buzzwords in the world of investing, but they are now fast becoming incorporated into BAU for the financial services sector and many of our clients at Bovill.

The increasing popularity of sustainable and responsible investing, as well as the growing economic argument in its favour, have resulted in regulatory and policy change across the world, with the UK often taking a pioneering role.

Last year, European regulator ESMA proposed changes to MiFID II requiring advisers to incorporate clients’ sustainability preferences as part of the existing suitability process. Following Brexit, similar proposals are likely to be introduced by the UK government, but the details and timing are still unknown.

The proposed requirement to take clients’ ESG or sustainability preferences into account when giving advice is likely to be a game changer for investment advisers. For the first time, firms will have to consider specific, non-financial factors when carrying out a client suitability assessment and when demonstrating ongoing suitability. The requirement will be applicable whether giving advice on a specific product or service, or when managing a portfolio.

What are ‘sustainability preferences’ when it comes to suitability?

What exactly do we mean by a client’s ‘sustainability preferences’? As the term suggests, you are trying to understand the extent to which your client would like you to consider investments that are:

  • environmentally sustainable – that is, investments which contribute to an environmental objective
  • have a positive social impact – that is, investments which contribute to a social objective such as reducing inequalities or directly improving the outlook for disadvantaged communities
  • good governance investments – by which we mean in a company that exhibits good governance, with good remuneration practices and employee relations.

Of course, so much of this is subjective. There are many shades of green and one of your key challenges will be to put some structure around this for your clients and ensure that you are capable of delivering against their views.

So, we have the prospect of fundamental changes affecting the whole industry – but a lack of clarity as to when any equivalent requirements will come into place and what they will look like.

ESG and suitability – how to get ready

We may not yet know the specific details and timing of the new requirements, but there are a few things you can do to be prepared:

  • First thing is to decide on your investment strategy. Is sustainable investing a core part of your offering married to an existing suite of relevant ESG products, or will you simply be using ‘green’ components to enhance your existing product set?
  • You will need to be able to clearly explain to clients what you can and cannot do for them in this regard. Disclose the extent of your ESG investment capabilities up-front to manage client expectations.
  • How will you, or your colleagues, educate yourselves on the basics of E, S, and G – sufficient to have a valuable conversation with your clients? Some of them may already know more about this topic than you do!
  • How will you engage with clients and record their views; is it an extension of your normal client profiling conversation or might you introduce an ESG-specific questionnaire, to really unpick what your client believes in?
  • You will need to match the client’s preferences with suitable investments – but don’t forget that their ‘normal’ financial objectives will always take precedence over their ESG standpoint.
  • And you will have to demonstrate that you have taken all of the client’s views into account in your recommendations, the portfolios you build, and the suitability letters you send out.
  • Data becomes king. The regulators are hoping to put in place requirements to ensure we are all comparing apples with apples. We cannot give suitable advice in this area without recourse to quality research and analysis.
  • Once all of that has been done at the outset, we must not forget the ongoing suitability process. How will you analyse the investments you have made on behalf of clients to make sure they are still capable of aligning with the client’s original preferences?

We may not know when the UK will adopt similar ‘MiFID suitability’ requirements, but there is a very clear direction of travel and the UK Government has always committed to being at the forefront of sustainability. At Bovill we are therefore advising our financial advice clients to get ahead of the game and start preparing for this eventuality now.

This article first appeared in Money Marketing Magazine on 16th February 2021: Get ready for new rules on ESG and advice suitability

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