Regulating ESG investments

This article is part of
Guide to responsible investing

Regulating ESG investments

Interest in environmental, social and governance investing is manifesting in several ways, and not just through protests by Extinction Rebellion and other campaign groups.

It is also starting to appear in financial services regulation.

Earlier this year, EU financial regulator the European Securities and Markets Authority put forward a series of additions to the already vast Mifid rulebook to bring in ESG and sustainability measures.

Muddying the waters

However, ESMA was deliberately vague in some of its additions, citing the immature nature of the ESG investing market.

The regulator did not want to put the EU at a competitive disadvantage to other countries and regions by being too prescriptive.

As a result, Mifid amendments include statements such as: “Where ESG considerations are relevant for the provision of investment services to clients, firms should take them into account.”

The Financial Conduct Authority’s 1,000-page implementation document for the EU rules did not do much to make things clearer.

As ESG concerns and climate change grab more of the public’s attention and become more of a concern to clients, how should advisers proceed?

Key Points

  • Mifid requires advisers to consider ESG concerns with their clients
  • The EU is working on a taxonomy for green credentials
  • The suitability of a product will trump any green credentials

Des Fitzgerald, senior policy adviser at the adviser trade body Pimfa, explains that Mifid requires financial advisers to “take sustainability into account” when going through a suitability assessment.

However, “what ‘sustainable’ is remains unclear”, he says.

Advisers should not expect the FCA’s handbook to be updated with a set of explicit ESG rules, Mr Fitzgerald adds.

He says: “It’s more likely to be an organic evolution of practice and experience, because advisers and firms need to factor in issues like the Financial Ombudsman Service and how it will interpret cases where there is a dispute about sustainable finance, in the absence of specific rules.”

Mike Barrett, consulting director at The Lang Cat, also highlights the regulator’s PROD handbook as the best guide for how to take ESG factors into consideration, especially as the wording of Mifid is “not that prescriptive” in this area.

The FCA’s handbook explains that product providers must analyse their client base and identify a specific target audience for any new product.

For distributors – which, in the FCA’s language includes financial advisers – the requirements are similar: advisers must assess their clients’ needs before identifying appropriate products. As Mr Barrett explains, failure to do this could result in a “clear breach” of FCA rules.

Pimfa’s Mr Fitzgerald says: “In practical terms, the adviser meeting a retail client will have to assess how relevant a green investment is to a consumer, based on that consumer’s circumstances. But ultimately the suitability of a product will trump any green wishes.

“So if you have £100 and you need £10 a year to pay for food, and the only investment that will replenish the £10 is in a less-than-A-rated green product, this would be okay as the need for £10 trumps the need for green.