Can it also be green? – The sustainability preference Inquiry according to MiFID II
Since August 2022, financial, asset and investment advisors have to ask their clients about their sustainability preferences and take them into account in their investments, according to the amendments of the Delegated Regulation of the European Union on Markets in Financial Instruments II (EU MiFID II). This new requirement is causing uncertainty for many of those affected.
Progress towards a more sustainable future is very real and currently unfolding all around us. According to Statista, it is important for almost 50% of all private investors in Germany to invest their money in companies that offer sustainable products or services!
According to the data analyses of the German fund association BVI, it can be assumed that almost every sixth euro that German customers invest in funds is invested in products with sustainability features. It is clear that many people want to make a contribution with sustainable financial products to make the world a little better. A few years ago, this was unimaginable, but the trend is clear: it is impossible to imagine everyday life without the topic of sustainability, and it is becoming increasingly important for every individual, as well as for banks and insurance companies.
The customers of tomorrow
The new attitude toward a more conscious lifestyle is noticeable and spreading very quickly, driven primarily by social media and other digital platforms. The flood of data and information is overwhelming and instantly available everywhere.
It can be assumed that in the future, well-informed, digitally-savvy, ethically-motivated and very sustainability-conscious people of the middle generation will make up an ever larger share of the customer. They are interested in products and services that do not harm the environment or people, regardless of price. Sustainability is on everyone's mind, but with regard to investments, it is particularly important for educated and wealthy investors in the middle to upper middle class. They expect not only a return at a reasonable risk, but also to achieve something meaningful with their investments.
But how do you approach these people? Above all, very well prepared, dynamic, but also empathetic. Contrary to expectations, personal consultations in banks and insurance companies are once again gaining in importance. The direct discussion is central, also in order to prepare the authoritative ESG regulations of the EU in an understandable way and to connect the multitude of investment possibilities in a targeted manner with the needs of the modern customer. This means that advisors in particular must be up to date on the latest sustainability trends and be well prepared to meet the customers of the future where they are.
The urgency of the increase in knowledge is clear
The magic triangle of investment advice, return - risk - liquidity is thus now supplemented by the dimension of sustainability to form a quadrilateral. And this on all levels of ESG, i.e. on the environmental and social level as well as under aspects of governance. These four levels must be brought into harmony.
So what does this mean for the consulting session?
First and foremost, of course, is good preparation for the advising session. If you are familiar with the concepts of sustainability and sustainable investments, as well as all the regulations and directives, the consultation will be more pleasant for everyone.
In fact, there are also advisory and knowledge standards for investment advisors that are expected by ESMA, i.e. the European Securities and Markets Authority (for more information, see "ESMA guidelines on some aspects of MiFID II requirements"). This provision assumes that investment advisors understand the ethical standards to which their associated institution is committed, in addition to the regulatory requirements. A new draft regulation from the Federal Ministry of Economics and Climate Protection even proposes that the topic of sustainable financial investment products should be the subject of the expert examination in the future, but this has yet to be finally decided.
The Sustainability Preference Check according to MiFID II
In order to redirect capital flows into sustainable investments, the Sustainable Finance Action Plan was developed by the European Commission. Within this action plan, 10 measures are defined. The fourth measure is "Consideration of sustainability in investment advice" and resulted in the amendment and extension of the MiFID II regulation, i.e. the "Markets in Financial Instruments Directive".
This is where advisors come into play. Since August 2022, MiFID II has made it mandatory to ask existing or new clients about their sustainability preferences during the next advisory service and to include them in the investment advice.
Inquiring about sustainability preferences gives clients the opportunity to determine whether and, if so, which aspects of sustainability are important to them when investing. These preferences must then be taken into account when recommending suitable financial products.
Driving the transformation forward
This approach is of fundamental importance for the successful support of the EU goals of also mobilizing private capital for the transformation of the economy. To achieve this, it is also important to promote and consolidate awareness and acceptance among customers and investors. In this way, investment consulting plays an essential role in the realignment of the financial system.
Ultimately, it is important that the basic question "Do you have sustainability preferences for your investments?" should not end in a simple yes/no answer, but should lead into a precise needs analysis of the customers' wishes. To help advisors through the jungle of this new regulation, various institutions have developed tools such as explanatory documents or even their own programs.
The Forum Nachhaltige Geldanlage (Forum for Sustainable Investment), for example, has produced a helpful guide to querying sustainability preferences under MiFID II. This guide provides good orientation. Click here.
The process
The first step is the familiar acquaintance phase, in which the usual questions are asked (income, loans, other financial investments, risk attitude, investment amount and investment period) in order to find the right financial instrument.
This is followed by the sustainability preference inquiry, which can be divided into 5 steps:
1. Preparation and initial questions
In the first step of the sustainability preference inquiry, the opening question is asked, in which the customer's values and interest in sustainability are assessed.
For this purpose, the customer's previous knowledge and wishes regarding sustainable investments should be asked. It is particularly important to understand the customer's individual understanding of sustainability and personal needs. What topics are particularly important to the person in the area of sustainability?
In addition to age, occupation and family situation, purchasing behavior, for example, can also be informative in order to gain an insight into the importance of sustainability in the customer's life. One way to get started could be to talk about current political events such as world climate summits or climate demonstrations, as well as current climate catastrophes.
2. Do you want to consider sustainability aspects in your investment decision?
After learning more about the customer's understanding of sustainability, the second step follows. Here, the main question is directed at the customer regarding the following three sustainability preferences:
When investing in financial products, should sustainability aspects be taken into account either
- in accordance with the Taxonomy and/or
- the Sustainable Finance Disclosure Regulation (SFDR) and/or should
- attention be paid to potential adverse impacts on sustainability factors?
Option 1 would be to invest in a way that qualifies as "environmentally sustainable". This would focus on financial products that make a significant contribution to one of six environmental goals, such as climate protection or protection of water resources.
The second option would be to invest in a financial product that, in addition to environmental factors, also promotes social goals and good corporate governance, such as social housing or a diverse or heterogeneous employee composition. In the two options mentioned so far, investments would be made in products and companies that are already "positive", i.e. sustainable.
The third option, on the other hand, focuses on avoiding anything particularly negative. With this investment option, certain negative effects on the environment and/or society are excluded.
At this point, it is a good idea to provide the customer with a basic understanding of the regulations and to respond to any questions. Most customers will not fully understand the concepts and regulations, but they do not have to. It is sufficient if the basic differences and options are communicated to the clients. For this, the advisors themselves must have informed themselves extensively in advance about the most important regulations. The customers can also be informed in advance in a preliminary discussion or, for example, via an information brochure about what sustainability, sustainable investments and the preference inquiry are in general. Overviews, charts or icons can be an essential support in the consultation.
If it is clear that the client would like to invest according to the EU Taxonomy and/or the Disclosure Regulation (SFDR), a minimum percentage should be specified for the proportion of sustainable investments to be taken into account by the advisor in the investment process. It can be decided between 20, 40, 60, 80 or even 100%.
3. Supporting transformation
Above all, when a portfolio is put together for the customer, the question remains as to whether the customer only wants to invest in companies that are already operating sustainably or also in those that are on the path to transformation toward sustainability.
4. Open questions
After explicitly addressing the wishes and demands of:the customer:in on the topic of sustainability and investments, the last step would be - to provide space for open questions.
To ensure that no step or important question is forgotten during the consultation, a questionnaire should be used. This guides both the consultant and the customer safely through the preference inquiry and also serves to document the results of the inquiry. This provides a safeguard - but also liability security for the bank. Various providers or financial institutions themselves have created such documents, but so far there is no uniform or binding solution for all. A proposal for a generally valid questionnaire has been made, among others, by the Defino Institute for Financial Standardization in cooperation with representatives of the DIN committee. You can find it under this link: Click here.
5. The product recommendation
At the end of the consultation, there should of course be a product recommendation that is adapted to the wishes and needs of the customer. For example, you can put together a flexible mix of sustainable funds. The ESG investment solution should be in line with the customer's ESG preferences, but should not violate the general investment objectives such as return.
If only one or even no financial product meets the preferences and ideas of the investor, nothing should be recommended. It is best to explain why this is the case and what the other options are. Ideally, the customer will adjust the sustainability preferences so that the product spectrum is broadened and other products can be recommended.
Not sustainable?
Not all customers are open to sustainable investments from the outset. There are non-sustainable, "ESG-neutral" and sustainable customers. People who have no sustainability preferences are recorded as ESG-neutral. In this context, the advisor should also explain to the potential investor that without an ESG preference, the entire investment universe is available for investments and therefore sustainable investments may also be offered.
Be sure to document everything!
Regardless of whether the customer decides in favor of a sustainable investment opportunity, documentation and justification for each step is mandatory! This means: It must be noted in the declaration of suitability whether and which ESG preferences were expressed or whether the customer is ESG-neutral. For example, the questionnaire can state whether the characteristics of the proposed financial instrument or the investment solution correspond to the customer's ESG preferences. Any deviations of the investment solutions from the expressed sustainability preferences must be noted here.
The role of the consultants
Sustainable consulting does not only mean advising on sustainability, but also making the consulting process sustainable by acting and communicating transparently to the clients, not making false promises of expectations and, most importantly, implementing a long-term dialogue. We are on a long journey when it comes to sustainability, in which the goal has not yet been reached and new regulations, directives but also investment opportunities appear at short intervals.
The consultation and sustainability preference inquiry are complex, time-consuming, but very important processes for redirecting capital flows in the sustainable direction in order to collectively manage transformational finance. The sustainability preference inquiry and MIFID II questionnaires are not barriers to this, but can be a tool to better understand and redirect capital flows into sustainable options. Working with clients around the topic of ESG, building up their own expertise and sharing this knowledge can even lead to an increase in individual sales results in the long term.
By awakening investors' interest in sustainable investments, advisors support the achievement of sustainability goals. This is because, through the advice and the resulting ESG investment solution, customers can, in the best case, make a contribution with their capital to environmental and social sustainability and thus to a world worth living in.