On 23rd September 2022, ESMA published its final report and revised guidelines on MiFID II suitability requirements detailing how it expects firms to implement the recent sustainability preference (“SP”) requirements integrated into the MiFID II Delegated Regulation.
As you will be aware, from August 2022, EU investment managers and financial advisers have been required to obtain and incorporate their clients’ “sustainability preferences” in the suitability assessment they undertake when making investment decisions / personal recommendations, and pending the final Guidelines being published, firms have used the draft guidelines (published in January 2022) as a guide for getting ready and beginning to apply these rules (albeit the EU authorities have acknowledged a degree of forbearance until the end of 2022). You can find our detailed client note on the draft guidelines here.
Many of the final guidelines remain as drafted in the January 2022 proposals, but there are a few noteworthy changes:
- Obtaining SPs for existing clients: The Guidelines continue to state that the SPs must be obtained by the next regular update of the client’s information or during the first meeting with the client after 2 August 2022. The Guidelines now confirm that until such point the client is deemed to be “sustainability neutral”, however they add the requirement that clients should be provided with the opportunity to have their profile updated (with respect to SPs) immediately if they so wish.
- PAIs: Detailed guidance is given on the questions that firms must ask in order to get information on SPs. It remains the case that there is no requirement to test the clients appetite for PAI families – this remains a suggested option. On PAIs, the updated guidelines now additionally state that “firms could also ask the client if there are specific economic activities that, on the basis of relevant PAIs, it wishes to exclude from its investments (for example, specific economic activities that are considered as significantly harmful under the EU taxonomy framework and/or that are opposed to the environmental and ethical views held by the client and that are linked to certain principal adverse impacts on sustainability factors” – but as this is prefaced with a “could” we think this too is not required but optional.
- Minimum proportion: Where a client expresses preferences in terms of the minimum proportion, the proposals previously specifically stated that ranges were permitted. The reference to ranges has now been replaced by a reference to standardised minimum percentages. However, the Guidelines say the following (which suggests that there may be scope to use ranges): “Where the client expresses preferences in terms of the “minimum proportion” as mentioned in points (a) and (b), firms could collect this information not in terms of an exact percentage but by minimum percentages. These percentages should be presented in a neutral way to the client and should be sufficiently granular. Firms could, for example, assist the customer to identify the minimum proportion by approximating the minimum proportion by standardised minimum proportions, such as “minimum 20%, minimum 25%, minimum 30%, etc.”.
- Client doesn't specify SPs or doesn't answer the question of whether it has SPs: The final Guidelines continue to provide that in such circumstances the firm may consider this client as “sustainability-neutral” and recommend products both with and without sustainability-related features. However the following text from the guidelines has been deleted, which suggests there is no need to mention the product’s sustainability features in these cases: “The firm’s product offer should be documented and explained to the client with a mention of the products/portfolio’s sustainability features.”
- Client doesn't specify granular enough SPs: the Guidelines now require firms to have policies and instructions for their client-facing staff in place for situations where clients state they have SPs but don't give granular enough information. The guidelines state that in these scenarios a firm could recommend products that meet any aspects of the 3 SP limbs generically selected by the client – but should then explain its approach and the sustainability features of the product recommended, and should document in the suitability report the client’s choice not to further specify the sustainability preferences.
- Combinations of SPs: References to obtaining information on whether clients want a combination of SPs have been deleted (other than a “could” reference in paragraph 27 of the Guidelines) – this suggests that there is no requirement to ask clients if they want SPs applied in combination. Similarly it would seem that a firm can meet client SPs under the MiFID II rules by meeting at least one limb where the client has expressed a combination (rather than meeting all the limbs).
- Adaptation of SPs: The Guidelines continue to provide that where a firm intends to recommend a product that does not meet the initial sustainability preferences of the client in the context of investment advice , it can only do so once the client has adapted his/her sustainability preferences. The firm’s explanation regarding the reason to resort to such possibility as well as the client’s decision should be documented in the suitability report. The updated Guidelines additionally state that after the client has expressed the intention to adapt its preferences, and not before, the firm could disclose to the client information about its offering of products with sustainability features.
- Firm does not have products meeting the clients SPs: The draft guidelines previously stated that where a client states that he/she has sustainability preferences, and the firm does not have any products with sustainability related factors available, this should also be documented in the suitability report. Whilst this wording has been deleted in the final guidelines, it would nevertheless be sensible to follow the same steps in practice.
- Robo-advice: Firms are required to have arrangements in place to meet these requirements where they give robo-advice with limited human interaction – this is particularly the case in scenarios where clients indicate they have SPs but have not given a firm sufficient granularity / specification.
- Changes outside the SP context: Firms should note that the final Guidelines additionally contain updated guidance on the suitability process outside of the SP context in the MiFID II guidelines. This includes new guidelines which provide that when assessing knowledge and experience, a firm should also avoid using overly broad questions with a yes/no type of answer and/or a very broad box ticking self-assessment approach.
The Final Guidelines will apply from 6 months from the date of publication of the guidelines on ESMA’s website (so around March 2023)
The assessment of suitability is one of the most important requirements for investor protection in the MiFID framework. It applies to the provision of any type of investment advice, whether independent or not, and to portfolio management