From early August, financial advisers have been required to incorporate sustainability preferences into their clients’ suitability assessment. However, many advisers have struggled to adapt their processes, with relatively loose guidance provided by the regulator, and a lack of clear measurement tools.
While many advisers have integrated some sustainable options into their investment proposition, recent research suggests that many are still not having in-depth, proactive conversations with their clients about sustainability. A recent study from Oxford Risks showed 46% of adults with investment portfolios managed by wealth managers had never been contacted by them about their attitude to ESG and responsible investing.
It appears many advisers lack the confidence to talk about ESG with clients. This isn’t helped by the word salad of terminology and a lack of commonly-agreed terms. They need to demonstrate how a clients’ preferences align to the sustainability measures, including incorporating the client’s capacity for loss and many do not yet have the tools in place to do this. They will also need independent data to validate their recommendations. It is perhaps no wonder some advisers feel at sea over the implementation of the new rules.
Finding a solution
That said, the regulation is here and needs to be observed, so advisers need to find a way through the challenges. It is worth noting that it may also present an opportunity for advisers. The same Oxford Risks study showed nearly one in three clients (31%) would invest more if their portfolio better reflected their views on ESG and responsible investing.
The regulator has given little clear guidance on how suitability processes should be structured. While this leaves advisers without a clear roadmap, it also gives them the flexibility to device their own processes.
As it stands, there are only a few rules that advisers need to observe. The first is that sustainability preferences come second to a clients’ financial goals and capacity to take risk. Allocating a proportion of a clients’ portfolio to sustainable or ESG investors is likely to change the investment mix, potentially ruling out income-generative areas such as mining and fossil fuels or focusing on higher growth areas such as renewable energy. Advisers need to find the right balance and ensure that the sustainability element doesn’t push a client away from their risk parameters.
The regulator has said that a client’s sustainability preferences can be implemented by allocating a minimum proportion of their portfolio to article 8 or 9 products under SFDR or MiFID investment that considers Principal Adverse Impacts. This could be a confusing message. Would a client who is sold on the merits of sustainable investment still want half their portfolio in non-sustainable investments? Advisers will need to make this decision.
There are also challenges around data availability and reporting. While regulatory initiatives such as the European environmental and social taxonomies are helpful, reporting is still in its infancy. As such, a lot of the data required to map suitability requirements to investment solutions is not available today. This is improving, but advisers have to work with imperfect information.
Help at hand
Undoubtedly there are likely to be teething problems when implementing the new rules. However, data availability and analysis are improving all the time as investment managers and the companies in which they invest align themselves with the new regulatory framework. This gives a common language for disclosure and reporting and a better understanding of the issues at stake, Admittedly, this is more challenging in some areas than in others. Environmental metrics are well-established, but social metrics are still being defined.
Advisers are also seeing risk analysis groups adapting their frameworks to accommodate sustainability preferences, which should help advisers build the new requirements into their business. Rating agencies are providing more granular information to help map those requirements to the right investment solutions.
The tools are out there for advisers to shape solutions in response to the new requirements. It is worth remembering that there appears to be significant client demand for ESG and responsible investing solutions, so there is carrot as well as stick for advisers implementing the new rules.
