In our first article about sustainable investments, we gave an introduction to ESG and highlighted the main points of interest, as well as the technological solutions to be adopted for its management.
We indicated that ESG criteria are used primarily to obtain a differentiated view of a company, which allows the Portfolio Manager to hedge risks and identify opportunities for enhanced returns but also that:
- Sustainability is not an additional criteria that can be freely adopted for investment evaluation, but it must comply to specific regulatory requirements.
One of the fundamental aspects of the previous point was that ESMA had recognised as good practice for Wealth Managers to assess non-financial elements when collecting information on the client’s investment objectives, including acquiring information regarding client preferences on environmental, social and governance factors.
In light of this, the Commission Delegated Regulation (EU) 2021/1253 of 21 April 2021, providing amendments to Delegated Regulation (EU) 2017/565, has specified what is meant by sustainable preferences and indicated the areas and ways in which they must be taken into consideration. It shall apply from 2 August 2022.
Sustainability preferences means a client’s or potential client’s choice as to whether and, if so, to what extent, one or more of the following financial instruments shall be integrated into his or her investment:
- a financial instrument for which the client or potential client determines that a minimum proportion shall be invested in environmentally sustainable investments, as defined in Article 2, point (1), of Regulation (EU) 2020/852 and Article 2, point (17), of Regulation (EU) 2019/2088;
- a financial instrument that considers principal adverse impacts on sustainability factors where qualitative or quantitative elements demonstrating that consideration are determined by the client or potential client.
Sustainability risk must be taken into consideration also in the context of general organisational requirements and risk management: investment firms have to 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 risks.
Investment firms shall provide a description of, where relevant, the sustainability factors taken into consideration in the selection process of financial instruments; the recommended investments, however, have to meet the investment objectives of the customer, including their risk tolerance and any sustainability preferences.
An investment firm shall not recommend financial instruments or decide to trade such instruments as meeting a client’s or potential client’s sustainability preferences when those financial instruments do not meet those preferences. The investment firm shall explain to the client or potential clients the reasons for not doing so and keep records of those reasons.
Where no financial instrument meets the sustainability preferences of the client or potential client, and the client decides to adapt his or her sustainability preferences, the investment firm shall keep records of the decision of the client, including the reasons for that decision.
Regulation (EU) 2019/2088 defines the proper identification of sustainability factors and risk.
When collecting customer sustainability preferences, through a specific ESG questionnaire, in addition to the traditional one, it is fundamental to acquire information that is sufficiently granular and consistent to allow a thorough consideration of the suitability assessment and stock selection.