The Regulation (EU) 2019/2088 of the European Parliament and of the Council (SFDR Sustainable Finance Disclosure Regulation) requires a financial product’s documentation to describe how its stated levels of sustainability or sustainability ambitions (e.g. ESG factors = Environment, Social and Governance) are to be achieved or are achieved. As it is not a labelling regime, different sustainability-related ambitions might be described. Therefore the MiFID II Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences for investment firms has been issued in 2021.

The draft of the MiFID II Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms issued on the 21st of April 2021 aims at clarifying that investment firms providing financial advice and portfolio management should carry out a mandatory assessment of sustainability preferences of their clients or potential clients. These investment firms should take these sustainability preferences into account in the selection process of the financial instruments that are recommended to those clients according to the new MiFID regulation. Three categories of financial instruments should be integral to sustainability preferences, namely financial instruments that pursue a minimum proportion of sustainable investments in economic activities that qualify as environmentally sustainable under Article 3 of the Taxonomy Regulation or financial instruments that pursue a minimum proportion of sustainable investments, as defined in Article 2, point (17), of the SFDR, where the minimum proportion is determined by the client or potential client. The third category of financial instruments eligible for individual sustainability preferences are financial instruments that consider principal adverse impacts on sustainability factors, where elements demonstrating that consideration are determined by the client or potential client.

Sustainability preferences according to MiFID Delegated Regulation (EU) 2017/565

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) 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 of the European Parliament and of the Council (Taxonomy Regulation)

Art 3 of the taxonomy regulation states that:

For the purposes of establishing the degree to which an investment is environmentally sustainable, an economic activity shall qualify as environmentally sustainable where that economic activity:

(a) contributes substantially to one or more of the environmental objectives set out in Article 9. These are: (a) climate change mitigation; (b) climate change adaptation; (c) the sustainable use and protection of water and marine resources; (d) the transition to a circular economy; (e) pollution prevention and control; (f) the protection and restoration of biodiversity and ecosystems.

(b) does not significantly harm any of the environmental objectives (Do No Significant Harm – clause)

(c) is carried out in compliance with the minimum safeguards laid down in Article 18 (Good governance) and

(d) complies with technical screening criteria that have been established by the Commission

(b) a financial instrument for which the client or potential client determines that a minimum proportion shall be invested in sustainable investments as defined in Article 2, point (17), of Regulation (EU) 2019/2088 of the European Parliament and of the Council (SFDR)

‘Sustainable investment’ according to Art 2 (17) SFDR) means

  • an investment in an economic activity that contributes to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy, or
  • an investment in an economic activity that contributes to a social objective, in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations, or
  • an investment in human capital or economically or socially disadvantaged communities,
  • provided that such investments do not significantly harm any of those objectives (DNSH) and
  • that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance;

(c) 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

Art 7 (1) of the SFDR defines that a financial market participant shall disclose a clear and reasoned explanation of whether, and, if so, how a financial product considers principal adverse impacts on sustainability factors. ‘Sustainability factors’ mean environmental, social and employee matters, respect for human rights, anti‐corruption and anti‐bribery matters.

Based on this definition the investor has the possibility to choose in which categories he may not want to invest.

A (Draft) Regulatory Technical Standard splits the sustainability factors in these 14 categories:

Climate and other environment-related indicators:

Greenhouse gas emissions        

1. GHG emissions

2. Carbon footprint

3. GHG intensity of investee companies

4. Exposure to companies active in the fossil fuel sector

5. Share of non-renewable energy consumption and production

6. Energy consumption intensity per high impact climate sector

Biodiversity      

7. Activities negatively affecting biodiversity-sensitive areas

Water  

8. Emissions to water

Waste  

9. Hazardous waste ratio

Social and employee, respect for human rights, anti-corruption and anti-bribery matters:              

Social and employee matters  

10. Violations of UN Global Compact principles and Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises

11. Lack of processes and compliance mechanisms to monitor compliance with UN Global Compact principles and OECD Guidelines for Multinational Enterprises

12. Unadjusted gender pay gap

13. Board gender diversity

14. Exposure to controversial weapons (anti-personnel mines, cluster munitions, chemical weapons and biological weapons)

Wrap Up

The sustainability preferences according to MiFID should only be addressed within the suitability process once the client’s investment objective has been identified. The aim of the rules on sustainability preferences is to enhance potential clients’ or clients’ awareness of the availability of financial instruments’ with sustainability ambition. The sustainability features of the financial instruments should be presented in a transparent way that allows investment firms to engage in dialogue with clients or potential clients in order to have sufficiently granular understanding of the clients’ individual sustainability preferences. Contact us to set up your consulting processes according to the new MiFID requirements for your clients.

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Georg Tichy

Georg Tichy is a management consultant in Europe, focusing on top-management consultancy, projectmanagement, corporate reporting and fundingsupport. Dr. Georg Tichy is also trainer, lecturer at university and advisor on current economic issues. Contact me or Book a Meeting