ESG will have a significant and long-term impact on financial markets in particular on the investment process in terms of regulation and customer/investor interest. The need for regulatory action relates specifically to MiFID II and the Disclosure Regulation. On the sales side, there is a demand for more support, transparency and clarification on this topic.
Read the following interview with Torsten Reischmann from Infront, who talks about the expected regulatory changes and their impact on the investment process.
Let's look at the investors first. How do you currently assess their interest in ESG products? Is there any data on this?
Torsten Reischmann: There are already many investors who are interested in ESG. Some of them only want to understand better and expect transparency about how their portfolio is perceived regarding environmental or social factors such as child labour or weapons production. A Square Mile survey of financial service providers shows a growing interest in specific ESG products, i.e. products that take ESG factors into account or even exclusively relate to sustainable investments. Among other things, the study asked, which share of the providers' customers would like to invest in ESG products.
These are the results:
Only 22% of respondents said more than half of their clients would wish to invest in a portfolio with an ESG steer or positive impact. Furthermore, 78 % of advisers indicated that less than 50% of their clients would wish to invest in an ESG-oriented, and 46 % claimed that less than 25 % of their clients would wish to do so.
What are the regulatory implications?
The new Disclosure Regulation, adjustments to MiFID and the forthcoming Taxonomy Regulation will all affect the investment process and lead to changes.
The Disclosure Regulation and MiFID aim at making it easier for investors to better understand products in terms of their ESG structure and to enable better orientation towards ESG preferences for investment advice or asset management.
What impact is expected from the Disclosure Regulation?
Torsten Reischmann: The Disclosure Regulation will become be effective as of 10 March 2020. From that date onwards, companies must first disclose on their website whether and how they account for sustainability aspects in their investment process. They will also have to provide pre-contractual information on the design of products that promote environmental or social aspects (so-called Article 8 products) or constitute sustainable investments (so-called Article 9 products). Further transparency requirements, including for non-EESG products, are expected to follow.
The timetable on sustainability factors:
Schedule for pre-contractual product information and regular product reporting:
What changes can be expected from the adaptation of MiFID?
Torsten Reischmann: The changes from Q4/2021 onwards are expected to take into account ESG preferences of investors. Therefore, ESG preferences are to be collected in context of profiling and, if corresponding preferences exist, they are also to be taken into account in the investment process. In addition, the product governance process for the target market must be expanded to include ESG topics. Building on this, preferences must then be taken into account in portfolio construction in asset management and investment advice to be validated via target market comparison and suitability check..
What do you see as the biggest challenges for the coming year?
Torsten Reischmann: Regarding the details of the incoming regulation, a lot of questions are still open. For example, in our understanding, MiFID currently provides for a higher requirement for ESG products than the disclosure regulation (also known as "Article 8 plus"). Another example is missing final templates for the pre-contractual and regular documents under the Disclosure Regulation.
At the same time, the big question is, which of the currently still rather limited data available on financial products is suitable to meet the classification and documentation requirements as soon as they have been specified.
How does Infront support its customers in this respect?
Torsten Reischmann: As with the last major regulatory changes, such as MiFID II and PRIIPS, we will support our clients as partners to implement an efficient, pragmatic and compliant solution. At the same time, we want to provide comprehensive support to those who consider ESG to be part of their business model, so that they can develop and manage appropriate products with our system.
Due to the many open topics, we have been looking at current regulatory developments in recent months and have assessed our understanding of the situation in dialog with our clients. We are also preparing our systems technically for the most likely implementation scenarios and are in discussions with all major data providers about available ESG data and re-vendoring models.
We are planning to conclude a re-vendoring agreement with a suitable ESG data provider for multi-layered ESG scores in the near future. This is expected to be available in the first quarter of 2021. The data integration is then scheduled for the first half of 2021 into all relevant portfolio management, advisory and terminal market data display. This will support our customers with standardized or customized screening-, monitoring- and reporting-use cases.
In order to specifically support the Disclosure Regulation, we are planning to provide system support for the pre-contractual and regular documents and the corresponding investment processes, e.g. pre-and post-trade checks, to be implemented as soon as the final RTSs (Regulatory Technical Standards) are available. The above-mentioned ESG scores can help control the reporting of products within scope of the disclosure regulation, even if it still requires specification (regulatory as well as company-specific). Since some clients have already chosen their own providers and defined their own investment processes, we will also support the use of any importable ESG data in portfolio management and advisory process solutions on a project-based level.
For special support of the MiFID extensions, we will adapt target market service, client profiling, target market matching and suitability testing, and extend the advisory process to include ESG aspects. Depending on the regulatory or institution-specific structure that still needs to be specified, the above-mentioned ESG scores can also be used in the investment and customer support processes - in addition to the expected expanded WM target market data.
What is important on the customer side?
Torsten Reischmann: If you haven't already done it, it is advisable to familiarize yourself in general with the regulatory requirements and potential effects.
Those who already operate ESG asset management today should consider marketing their products as ESG products in the sense of the Disclosure Regulation and MiFID and then report them to existing clients accordingly. As we see it, a different approach (with non-ESG products in a portfolio) is possible but problematic for end customers. If marketing as an ESG product (Article 8 or 9) is intended, the pre-contractual information has to be revised by March and the preparations for reporting from 2022 onwards have to be made.
Since MiFID will affect the entire investment advisory and asset management business, we recommend identifying the necessary adjustments (to customized workflows, reports, evaluations, etc.) as early as possible and planning the associated implementation (e.g. supported by Infront).