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MiFID ii – ESG & Sustainability upgrade

This has been a long time coming, but happily ESMA has recently (3 May 2019) published the reports that start the process of bringing investment markets into line with the EU’s Climate Action plan through the integration of sustainability and ESG factors throughout the investment chain, including financial advice.

The following is ‘cut and paste’ and related links from their material so that you receive this ‘direct from source’ .

(My aim is to go through this in more detail and set it out in a more easily digestible form shortly!)


Press release reads:

ESMA SUBMITS TECHNICAL ADVICE ON SUSTAINABLE FINANCE TO THE EUROPEAN COMMISSION

03 May 2019

FUND MANAGEMENT

MIFID – INVESTOR PROTECTION

SUSTAINABLE FINANCE

The European Securities and Markets Authority (ESMA) has published its technical advice to the European Commission (EC) on Sustainable Finance initiatives to support the EC’s Sustainability Action Plan in the areas of investment services and investment funds.

The two final reports contain technical advice to the EC on the integration of sustainability risks and factors, relating to environmental, social and good governance considerations with regards to investment firms and investment funds, into the Markets in Financial Instruments Directive II (MiFID II) (investment services), the Alternative Investment Fund Managers Directive (AIFMD) and the Undertakings in Collective Investment in Transferable Securities (UCITS) Directive (investment funds).

ESMA ran a public consultation and hearing on its technical proposals and conducted a cost-benefit-analysis and has taken into account the opinion of the Securities Markets Stakeholder Group (SMSG).

ESMA, to ensure consistency, has developed its final report in cooperation with the European Insurance and Occupational Pensions Authority (EIOPA), which has received a similar mandate regarding Solvency II and the Insurance Distribution Directive (IDD).

Next steps

ESMA’s initial consultation contained a separate paper on guidelines for disclosure requirements applicable to credit ratings, including the consideration of environmental, social and governance factors. The final report of this paper is expected to be published by the end of July.

Final Report: ESMA’s technical advice to the European Commission on integrating
sustainability risks and factors in MiFID II


Additional information:

Apologies for the formatting, resulting from cut & pasting…  but the published ‘Technical Advice’ includes the following:

See p 15 MiFID report

Technical advice

Article 21(1) of the MiFID II Delegated Regulation to be amended as follows
Investment firms shall comply with the following organisational requirements:
[…]
Where ESG considerations are relevant for the provision of investment services to clients,
firms should take them into account when complying with the above requirements.
When complying with the requirements set out in this paragraph, investment firms shall take
into account the nature, scale and complexity of the business of the firm, and the nature and
range of investment services and activities undertaken in the course of that business.
16
Article 23 of the MiFID II Delegated Regulation to be amended as follows
Investment firms shall take the following actions relating to risk management:
(a) establish, implement and maintain adequate risk management policies and procedures
which identify the risks relating to the firm’s activities, processes and systems, and where
appropriate, set the level of risk tolerated by the firm. In doing so, investment firms shall take
into account sustainability risk.
[…]
New recital 59 (bis) of the MiFID II Delegated Regulation to be added
When identifying the types of conflicts of interest whose existence may damage the interests
of a client, investment firms should include those that may stem from the distribution of
sustainable investments.
Firms should have in place appropriate arrangements to ensure that the inclusion of ESG
considerations in the advisory process and portfolio management does not lead to misselling practices, including as an excuse to sell own-products or more costly ones, or to
generate churning of clients’ portfolios, or to misrepresent products or strategies as fulfilling
ESG preferences where they do not.
New recital of the MiFID II Delegated Regulation to be added
In order for investment firms to comply with their risk management obligations to take into
account sustainability risk within their risk management policies and procedures, the
investment firms’ compliance function, internal audit function, management body and senior
management should also consider aspects related to sustainability risk in their respective
duties

See p20/21 MiFID report:

Technical advice
Article 9(9) of the MiFID II Delegated Directive to be amended as follows

Member States shall require investment firms to identify at a sufficiently granular level the
potential target market for each financial instrument and specify the type(s) of client for
whose needs, characteristics and objectives, and ESG preferences (where relevant), the
financial instrument is compatible. As part of this process, the firm shall identify any group(s)
of clients for whose needs, characteristics and objectives the financial instrument is not
compatible. Where investment firms collaborate to manufacture a financial instrument, only
one target market needs to be identified.

Article 9(11) of the MiFID II Delegated Directive to be amended as follows

Member States shall require investment firms to determine whether a financial instrument
meets the identified needs, characteristics and objectives of the target market, including by
examining the following elements:

[12 http://ec.europa.eu/finance/docs/level-2-measures/mifid-delegated-act-2018_en.pdf
21]

a) the financial instrument’s risk/reward profile is consistent with the target market;
and
b) the financial instrument’s ESG characteristics (where relevant) are consistent
with the target market; and
c) financial instrument design is driven by features that benefit the client and not by
a business model that relies on poor client outcomes to be profitable.

Article 9(14) of the MiFID II Delegated Directive to be amended as follows
Member States shall require investment firms to review the financial instruments they
manufacture on a regular basis, taking into account any event that could materially affect
the potential risk to the identified target market. Investment firms shall consider if the
financial instrument remains consistent with the needs, characteristics and objectives, and
ESG preferences (where relevant), of the target market and if it is being distributed to the
target market, or is reaching clients for whose needs, characteristics and objectives the
financial instrument is not compatible.

Article 10(2) of the MiFID II Delegated Directive to be amended as follows

Member States shall require investment firms to have in place adequate product
governance arrangements to ensure that products and services they intend to offer or
recommend are compatible with the needs, characteristics, and objectives, and ESG
preferences (where relevant), of an identified target market and that the intended distribution
strategy is consistent with the identified target market. Investment firms shall appropriately
identify and assess the circumstances and needs of the clients they intend to focus on, so
as to ensure that clients’ interests are not compromised as a result of commercial or funding
pressures. As part of this process, firms shall identify any groups of clients for whose needs,
characteristics and objectives the product or service is not compatible.

Article 10(5) of the MiFID II Delegated Directive to be amended

Member States shall require investment firms to review the investment products they offer
or recommend and the services they provide on a regular basis, taking into account any
event that could materially affect the potential risk to the identified target market. Firms shall
assess at least whether the product or service remains consistent with the needs,
characteristics and objectives, and ESG preferences (where relevant), of the identified
target market and whether the intended distribution strategy remains appropriate. Firms
shall reconsider the target market and/or update the product governance arrangements if
they become aware that they have wrongly identified the target market for a specific product
or service or that the product or service no longer meets the circumstances of the identified
target market, such as where the product becomes illiquid or very volatile due to market
changes.


Report links:

Mifid ii paper https://www.esma.europa.eu/file/51276/download?token=6b4Tp3Bu  FINAL REPORT ON INTEGRATING SUSTAINABILITY RISKS AND FACTORS IN THE MIFID II 
https://www.esma.europa.eu/file/51275/download?token=laoFYfvk   FINAL REPORT ON INTEGRATING SUSTAINABILITY RISKS AND FACTORS IN THE UCITS DIRECTIVE AND THE AIFMD

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