MiFID II and ESG preferences: A paradigm shift in Europe?

From August 2, financial product advisors and distributors will have to ask customers to specify their sustainability preferences. This is part of the European agenda to direct capital towards the most active companies in the transition to a low-carbon and inclusive economy.

We believe that this regulation is a powerful accelerator that empowers investors and improves transparency in a particularly dense regulatory environment where the fight against greenwashing is omnipresent.

Towards a more “tailor-made” portfolio construction

Placing the client at the center of the process by allowing him to express his investment choices will lead to a greater personalization of the portfolio, but will also allow a more harmonized Environmental, Social and Governance (ESG) product offer.

The MiFID questionnaire used to collect investment preferences and determine product suitability will be essential. It concerns environmental, social and governance criteria, product alignment with European taxonomy and “negative investment externalities”.

Investor responses will need to translate into a concrete product offering. This “à la carte” model presents a major challenge: Aligning preferences with fund characteristics.

Each distributor must draw up a questionnaire. Regulators will nevertheless be vigilant as to the interpretation of the legislation: the European Securities and Markets Authority (ESMA) recently clarified this point by providing the first elements of a normative framework. We consider this a welcome initiative which should lead to harmonized questionnaires.

New challenges for asset managers

In this new paradigm, the asset management industry plays an essential role: that of proposing a complete offer corresponding to all investor profiles, not only in terms of ESG preferences, but also of appetite for risk, portfolio diversification, liquidity, etc.

Management companies must ensure that the funds offered correspond to the expectations set by clients and distributors. In accordance with the stated objectives, the funds will either:

  • Limit negative impacts such as greenhouse gas emissions or gender pay inequalities
  • Include a share of assets defined as ‘sustainable’
  • Be in line with European taxonomy objectives such as climate change mitigation and ecosystem protection.

Currently, BNP Paribas Asset Management’s offer includes a range of products integrating ESG criteria with more than €330 billion in assets under management (end of December 2021) covering a wide range of sectors and geographies.

The introduction of the MiFID 2 rules should make sustainable funds even more attractive, but we will have to take care to maintain a balanced allocation of capital to avoid an excessive concentration of investments.

Data – An essential first step

In line with investors’ enthusiasm for sustainable finance, European regulators are stepping up their efforts and involving all stakeholders.

After the introduction of MiFID II, “Level 2” regulatory technical standards will apply from 1 January 2023. These will provide a solid framework for the communication of asset managers on so-called article funds. 8 and 9 under the SFDR regulations. Then, the Corporate Sustainability Reporting Directive (CSRD), still under discussion, aims to strengthen the financial and ESG reporting obligations of companies from 2024.

While we welcome the progress resulting from this regulatory framework, the regulatory order could have been better: if companies first disclose their ESG data in a transparent and harmonized way, management companies can use it in the construction of their fund offerings, and finally distributors can assess investors’ preferences for sustainable investments.

This sequence obliges us to collect extra-financial data from companies by other means. At BNPP AM, we have been using our proprietary rating methodology since 2018, covering over 13,000 issuers, to collect data on different ESG criteria, which we complement with information from other sources.

Technology – At the heart of MiFID II

To define the optimal portfolio allocation based on an investor’s ESG preferences, technology will be essential to collect and process ESG data, and ensure it is properly factored into investment strategies.

Technology will also occupy a prominent place in the offer to clients under MiFID II: algorithms will translate the constraints resulting from the questionnaires into optimal portfolios that meet the needs of investors.

Finally, technology is also a tool for teaching people. We advocate the use of digital journeys, for a fluid, simplified experience connected to portfolio construction algorithms.

All of this will allow for better diversified capital allocation and better risk control, aligned with sustainability issues.

Look forward

In the years to come, the establishment of sustainable finance legislation will be a major project for the financial services industry. We welcome and support the efforts of regulators to increase the transparency of available information, and actively engage with policymakers and governments to help them shape the markets in which we invest and the rules that guide and govern corporate behavior.

Much remains to be done, in particular to improve the quality of and access to companies’ ESG data. We are confident that MiFID II and various other regulations will ultimately bring more standardization for the benefit of clients.

Let’s not forget that this represents much more than a new legal framework, it is an important step towards a reallocation of capital towards ecological transition and social issues. Like any major upheaval, the transition is a long-term one and requires the help of all stakeholders: distributors, asset managers, regulators – and of course investors.

Warning

All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different views and make different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income from them can go down as well as up and investors may not get back their initial investment. Past performance does not guarantee future returns.

Investing in emerging markets, or in specialized or restricted sectors is likely to be subject to above average volatility due to a high degree of concentration, greater uncertainty as less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of developed international markets. For this reason, portfolio transaction, liquidation and custody services on behalf of funds investing in emerging markets may involve greater risk.

About Joel Simmons

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