ESMA encourages regulatory supervisors to adopt a ‘proportionate approach’ to firms implementing MiFID II sustainability requirements

Sustainability requirements within the MiFID suitability framework

Summary of ESMA findings and expectations 

Information to clients about the purpose of the suitability assessment and its scope

Most firms implemented at least some measures to help clients understand the new terms and concepts, but this was carried out with varying degrees of success across jurisdictions.

Many firms reported challenges in explaining the regulatory definition of ‘sustainability preferences’, in a way that clients can easily understand. 

Firms employed a range of educational tools to help clients understand the new definitions and concepts, with the questionnaire being the most popular means and often featured interactive elements like clickable icons or pop-up boxes.

Arrangements necessary to understand clients

There is a noticeable move towards more detailed and specific questionnaires compared with the early implementation phase of the legal requirements. However, some shortcomings were observed, such as instances where firms collect clients’ preferences only for those product categories included in their own offering, largely reflecting the limited availability of suitable products.

When collecting clients’ preferences regarding the consideration of Principal Adverse Impacts (PAIs), firms generally use qualitative approaches, often grouping impacts into broader categories such as environmental, social or governance factors or referring to the SFDR families of PAIs. Only a few firms collect more detailed preferences relating to specific PAI indicators.

Deficiencies were also identified in several jurisdictions where firms lack clear internal procedures for handling clients who did not express sustainability preferences. Deficiencies were also found with respect to the neutrality of the client engagement process, including the absence of formal policies and procedures.

The CSA also showed that firms take different approaches when clients express detailed preferences across more than one of the three product categories set out in the definition of sustainability preferences.

ESMA encourages firms to further enforce over time their processes to ensure that clients’ sustainability preferences are collected in a clear, neutral and sufficiently detailed manner. In doing so, firms should ensure that questionnaires remain usable and proportionate, avoiding unnecessary complexity or excessive technical terminology.

ESMA also expects firms to apply a proportionate approach to updating clients’ sustainability preferences and to avoid re-collecting preferences where recent and relevant information is already available, unless there is a material reason to believe the client’s circumstances or preferences have changed.

Arrangements necessary to understand investment products

ESMA encourages firms to continue strengthening the consistency of their product-categorisation processes and invites firms to regularly review and update their methodologies to support a reliable and effective matching of products to clients’ sustainability preferences. 

Pending the outcome of the broader SFDR and RIS reforms, ESMA considers that firms may apply proportionate categorisation approaches that reflect available data, provided these are consistent, well-documented and sufficient to support a MiFID-compliant suitability assessment. Firms are not expected to apply undue granularity where data limitations make such granularity unreliable.

For products with sustainability features that fall outside the scope of the SFDR, competent authorities reported that firms use a range of approaches to assess and categorise their ESG characteristics. These practices vary widely in terms of data sources, methodologies and criteria applied. Given the diversity of market practices and the limited availability of consistent data for these instruments, the current framework provides limited scope for convergence in approaches, suggesting that further legislative work is needed in this area.

Arrangements necessary to ensure the suitability of an investment

Some limitations were observed in the arrangements and procedures firms have put in place to integrate clients’ sustainability preferences into the suitability process.

The CSA shows that firms apply a range of approaches to implementing the portfolio approach, reflecting differences in business models, product offerings and operational frameworks. While these variations are expected, the exercise also highlights the importance of ensuring that the chosen approach is clearly articulated within firms’ internal arrangements, given its relevance for the consistent application of clients’ sustainability preferences.

Adaptation of clients’ sustainability preferences

ESMA acknowledges that in certain cases firms may face situations where the client’s initial sustainability preferences cannot be met due to limited product availability or insufficient granularity of existing product disclosures. In such circumstances, firms could proactively support clients by presenting products that are closest to the preferences expressed, ensuring that the advisory process remains clear, fair and not misleading. Any recommendation must continue to comply with MiFID II, including the requirement that clients be given the opportunity to adapt their preferences before a recommendation is made. 

Record keeping

Not all firms have implemented sufficient measures to ensure that records are complete and appropriately detailed. This is particularly evident in relation to the recording of preference adaptations and the rationale behind them, where in some cases only the final preferences expressed by the client are documented, without retaining information on the steps or explanations leading to those changes. 

ESMA encourages firms to ensure that the documentation related to clients’ sustainability preferences, the matching process and any adaptations made is sufficiently complete, clear and traceable.

Sustainability requirements within the MiFID product governance framework

Summary of ESMA’s findings and expectations

Target market assessment for products with sustainability-related objectives

The review of firms’ target market assessments shows that most firms have developed approaches to specify the sustainability-related objectives their products are designed to meet. In general, firms base these assessments on the regulatory definition of sustainability preferences introduced under the MiFID II Delegated Regulation. However, the level of detail applied varies considerably. Some firms define these objectives with insufficient granularity to allow an effective matching of products to clients’ preferences, while others have not yet fully developed processes to identify sustainability-related objectives as part of the target market assessment. 

Firms should continue refining the way they define sustainability-related product objectives over time to enable a meaningful and accurate match with clients’ sustainability preferences.

Assessment of the ‘negative’ target market for products that do not consider sustainability factors

Only few firms are considering the sustainability-related objectives in the negative target market assessment for products that do not consider sustainability factors.

Firms are encouraged to ensure that, where relevant, the negative sustainability-related target market is clearly articulated so that the distribution strategy remains aligned with the objectives and needs of clients.