ESG in investments
The beginning of the year was full of different forecasts. There was a lot of talk about the growing role of ESG, especially in the context of investments. Why are investments in the focus and will this affect the entire business and how? About it below…
Again those rules
In 2022, regulations came into force requiring companies providing investment services or managing investment portfolios to take into account ESG factors in the survey and offer for investors. This means that they now need to take account of the sustainability preferences expressed by their clients, and have in place appropriate processes and systems that address sustainability risks when selecting or recommending investment products. These obligations result from the changes introduced to the MiFID (Market in Financial Instruments Directive), and more specifically from:
Commission Delegated Regulation (EU) 2021/1253 of 21 April 2021 amending Delegated Regulation (EU) 2017/565 as regards the inclusion of factors, risks and preferences in the field of sustainable development in certain organizational requirements and operating conditions of investment firms which entered into force on August 2, 2022,
Commission Delegated Directive (EU) 2021/1269 of April 21, 2021 amending Delegated Directive (EU) 2017/593 as regards the inclusion of sustainability factors in product stewardship obligations, applicable from November 22, 2022.
The purpose of introducing these changes was to create a more transparent and consistent regulatory framework and to strengthen the two main legal acts in this area - SFDR and Taxonomy.
MiFID vs. SFDR and Taxonomy
With regard to investments, the provisions of the Taxonomy will help to increase the level of environmental protection by redirecting capital from investments damaging the environment to investments that are more environmentally friendly. Although the taxonomy does not prohibit investing in activities that are harmful to the environment, it positively "scores" investments that meet the criteria of taxonomy. Behind them are specific definitions and indicators that help determine whether a given activity is environmentally sustainable or not. This is to help companies develop strategies to enter new, more environmentally friendly technologies, mitigate market fragmentation and, as a result, help redirect investments to where they are most needed. The main purpose of the taxonomy is to redirect the financial stream towards economic activities that have the potential to reduce emissions and pollution by setting a specific framework, and thus increasing transparency in this area. In practice, the Taxonomy is intended to make it easier for investors to know whether they are investing their money in harmless sectors or sectors that reduce environmental damage, which are less risky. Most of the EU legal acts in the field of sustainable development that will be created in the near future will be based on taxonomy.
The purpose of the SFDR (Sustainable Finance Disclosure Regulation) is to achieve greater transparency regarding the method of analyzing risks to sustainable development that occur as part of the activities conducted by financial market participants and financial advisors.
Changes in MiFID introduce, among others, the obligation to research investor preferences, including ESG preferences. The response to these preferences should be an investment proposal taking into account the above-mentioned ESG aspects resulting from the SFDR and Taxonomy regulations. This means that companies offering investment products will have to prepare their offer for investors in such a way that it meets the expectations of clients regarding sustainable investments, in accordance with the criteria set out in the Taxonomy and SFDR.
How does it look in practice?
As we already know, it is now very important to know the expectations and preferences of client-investors. For this purpose, they will have to complete the MiFID questionnaire. It consists of several questions and its purpose is to determine the level of investment risk. Thanks to it, the client will find out in which products he can safely invest and which are more risky. In turn, a financial institution offering an investment product, thanks to the MiFID survey, will obtain information on what products it should offer to a given investor. However, simply checking the level of risk currently does not exhaust the regulatory obligations. From August 2022, financial institutions have to examine customer preferences also in the field of sustainable development. This means that questions in this area have been added to the MiFID survey.
The client-investor's preferences in terms of sustainable development are defined by specifying:
the minimum percentage of investment of its funds in economic activities that qualify as environmentally sustainable investments within the meaning of the Taxonomy,
a minimum percentage of investment of his funds in economic activities that qualify as sustainable investments within the meaning of the SFDR,
Including Principal Adverse Impacts (PAIs) on sustainability factors in the form of quantitative or qualitative information.
Other significant regulations
On the occasion of sustainable investment products, it is impossible to overlook Delegated Regulation 2021/1257 on the inclusion of sustainability factors in the requirements for the supervision and management of insurance investment products. It amends the provisions of the Insurance Distribution Directive, known as the IDD (Insurance Distribution Directive), and more specifically the provisions of the acts supplementing it, such as:
Delegated Regulation (EU) 2017/2358 as regards the inclusion of sustainability factors, sustainability risks and sustainability preferences in product oversight and governance requirements for insurance undertakings and insurance distributors and conduct of business rules and investment advice in relation to insurance investment products
Delegated Regulation (EU) 2017/2359 as regards information requirements and conduct of business rules applicable to the distribution of Investment Based Products (IBIP).
These regulations introduce significant changes in the activities of insurance companies. They concern the inclusion of sustainability factors in the product management system. As well as in the study of customer preferences in terms of sustainability as part of its distribution. In addition, under the new requirements, insurance companies and insurance intermediaries providing advice must obtain information from customers about their sustainability preferences for insurance investment products. After analyzing these preferences, insurance companies can offer customers "green" insurance investment products tailored to their needs. It is also becoming an obligation to gradually adjust the product offer to the new requirements in such a way that it includes products that comply with the customer's preferences in the field of ESG, i.e. those that include ESG elements in their essence or at any stage of the product's "life" cycle. The requirement applies to all insurance products created or subject to significant modification after August 2, 2022. However, it does not apply to products offered before the entry of these regulations.
Summary
As you can see, ESG is getting deeper and deeper into our everyday life. Sustainable investment requirements pose many challenges, both for companies that manage investment products and for companies and organizations whose debt securities are included in investment portfolios. Regardless of whether they are subject to the non-financial reporting obligation or not, they will still be forced to report their non-financial data. On their basis, the company managing investment products will be able to determine, for example, whether the inclusion of the shares of a given company in the portfolio will not increase the risk for the investor if its activity turns out to be insufficiently sustainable, or will reduce it if the company in which we invest has advanced activities based on the principles of sustainable development. Therefore, soon no company can do without ESG. The meaning of these three letters is becoming more and more important for business and over time they will have to become part of the DNA of every enterprise.