Investment professionals have given a mixed reaction to draft EU rules on integrating sustainability in the fiduciary duty of investment firms and insurers. These rules are tied to another piece of legislation currently being designed and whose outcome could lead to significant change… or further greenwashing. Vincent Huck reports
The European Commission has done exactly what it said it would do last June, and published draft rules on how investment firms and insurance distributors should consider sustainability topics when they advise clients.
In a nutshell, the rules mandate all investment managers to include questions about their clients’ environmental, social and governance (ESG) preferences in questionnaires and suitability assessments and disclose to their clients how those preference will be fulfilled.
Such requirements could apply to asset managers, insurance companies, pension funds or investment advisors.
The proposals are part of the Commission’s Sustainable Finance Action Plan and amend the EU directive on markets in financial instruments (MiFID II) and the directive on insurance distribution (IDD).
Reacting to the proposals, Josina Kamerling, head of regulatory outreach EMEA at the CFA Institute, asks if the European Commission is putting the cart before the horses.
“The Commission and Parliament are moving very fast on this topic, and the whole industry is very divided on it,” she says. “Even within CFA Institute, where there is an acknowledgement that ESG is here to stay, that we need to take into account and that it is something that is being asked of us by society. But the question is: how?”
Although everyone is aware that they have to deal with it, no one is completely aware on how far it should be fixed into law, according to Kamerling.
The CFA Institute supports getting ESG into the investment process, Kamerling says, but whether or not it should be part of fiduciary duty “is probably one step too far in our thinking”.
“We are not saying that you shouldn’t have a duty of care, but to put it into regulation is probably at the moment too far. More discussion needs to be had,” she continues.
Legislators are bringing in a lot of obligations, but Kamerling argues the data and measurement processes needed to make comparisons of sustainability are in their infancy.
“The investment manager’s duty is to produce good investment returns. In discussion with his client, shouldn’t he have the freedom to decide on what to do to achieve that?”
Eleni Choidas, European policy manager at responsible investment campaigner group ShareAction, says the Commission’s moves are a crucial step in ensuring “a strong voice for millions of citizens, but also that the financial system becomes increasingly democratised and transparent”.
The amendments to MiFID II and the IDD could help in mainstreaming the consideration of ESG risks in all investments, she continues.
“For one, independently of whether they coincide with the expressed preferences, firms should be disclosing, during the consultation process, all relevant ESG characteristics of products offered. This should include the impact of the investment on ESG issues a client may care about, not just the financial impact of the ESG preference on potential returns.
This is crucial, Choidas argues, as ESG preferences may be linked to the interest of a client to not negatively influence the communities and environment the investment interacts with independently of whether this effect is financially material - measuring and reporting on impact is a way to account for this category of preferences.
“In addition, firms should consider the ESG preferences of clients against all products in the portfolio, or at least, against the portfolio as a whole,” she says. “This would prevent the inclusion of products that may be incompatible with the preferences of the client, despite the inclusion of one product that may be perfectly aligned.”
Will Martindale, director of policy and research for the UN-backed Principles for Responsible Investment, welcomes the rules arguing they will “level the playing field, reward first-movers and help clarify that fiduciary duty requires the consideration and integration of ESG issues in investment decision-making”.
Steve Waygood, chief responsible investment officer at asset manager Aviva Investors, says: “It will be important to ensure that the detail of the proposals allows for a broad range of approaches to sustainable investment, including those that utilise active stewardship alongside asset allocation. We would encourage EU policymakers to continue to engage with financial firms to ensure this.”
Asked if the proposals will have a significant impact on Aviva Investors’ relationship with clients and if it will be burdensome to put in place, he says: “Clients are increasingly raising ESG proactively with us through their RFPs [requests for proposals], and we are looking at our process to capture ESG and other preferences effectively as part of always wanting to understand our clients and their priorities better.”
He adds: “ESMA [the European Securities and Markets Authority] has already said, ahead of the Commission’s proposed legislation, that to understand investors’ ESG preferences would be ‘good practice’. We do not see the proposed requirement as a burden, but rather as an opportunity to better connect with our clients and reflect their preferences in the products we offer.”
An empty shell regulation?
While the rules will provide a powerful weapon for inclusion of sustainability considerations in investment processes, the European Commission’s proposals come as an unloaded firearm, as they are tied in with the ESG taxonomy currently being designed.
The proposals can only be officially adopted once the taxonomy has been agreed and adopted at the EU level – and the taxonomy will be a crucial part of the success of the initiative. A poor taxonomy will allow unsustainable investments to qualify as sustainable, and enable investment managers to “greenwash” over the obligations.
Asked if she agreed with the firearm analogy, Kamerling says she wouldn’t say that, “but I do believe the Commission is putting the cart before the horse”.
We are in the last phase of this Commission, she warns. “And it is difficult to see if what is proposed will happen or is it ultimately going to be postponed for the next commission.”
With a new EU legislature to be formed after elections in May, there is extra pressure to get the rules finalised quickly. The political landscape is likely to be very different, and there is a risk the next Commission could alter course.
“I can understand the political environment and why you want to move, but perhaps PRIIPS [the packaged retail investment and insurance-based products legislation] should make us cautious in moving too strongly in one direction. PRIIPS has not been the success we hoped it to be,” she explains.
“At the moment it’s like Halley's comet, a flash across the sky of investment management. Is it going to disappear as fast again because it is just too much for too short a period without being duly thought out within all these other debates that are going on?”
Link to draft Mifid II proposals
Link to draft IDD proposals