As elaborated in our BSP Sustainable Finance Insights Series 6, on 8 June 2020, the European Commission published a set of draft delegated acts concerning the integration of sustainability factors under various legislative acts, including the Directive 2014/65/EU on markets in financial instruments (“MiFID”). The initiative was part of the European Commission’s action plan on sustainable finance, seeking to ensure end investors have clear information on the social and environmental risks and opportunities pertaining to their investments and to clarify the duties of investment firms while providing their clients with advice on the social and environmental risks and opportunities in respect of their selected investments.
As a matter example, financial instruments that pursue a minimum proportion of sustainable investments will always include financial products referred to in article 9 and to article 8 of the sustainable finance disclosure regulation (SFDR), provided such financial products pursue, at least to some extent, sustainable investment. That minimum extent is determined by clients, thus the rules on sustainable preferences take into full account their sustainability-related ambitions.
Where no financial instrument meets the sustainability preferences of the client, and the client adapts its preferences as a consequence, the investment firm shall keep records of the decision of the client including the reasons for the change.
For the product governance, Directive (EU) 2017/593 now refers to “sustainability related objectives” (providing for a larger scope) rather than sustainability preferences. Manufacturers are required to disclose sustainability factors of the financial instruments in a transparent way allowing investment firms to engage in dialogue with clients.
Both proposed delegated acts concerning MiFID (particularly (i) the Draft Commission Delegated Directive amending Delegated Directive (EU) 2017/593 as regards the integration of sustainability factors and preferences into the product governance obligations (the “Initial Draft Delegated Directive”) and (ii) the Draft Commission Delegated Regulation amending 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 (the “Initial Draft Delegated Regulation”) (collectively referred to as the “Initial Draft Delegated Acts”) were put to public a consultation from 8 June 2020 to 6 July 2020. On 21 April 2021, the European Commission formally adopted (i.e. proposed) the following amended Initial Draft Delegated Acts (the present Newsflash will focus on the changes made to the Initial Draft Delegated Acts):
1. Commission Delegated Directive amending Delegated Directive (EU) 2017/593 as regards the integration of sustainability factors into the product governance obligations (the “Adopted Commission Delegated Directive”).
In a comparative analysis between the Initial Commission Delegated Directive and the Adopted Commission Delegated Directive, the latter:
(i) removes the definition of “sustainability preferences” which was previously proposed to be added in the form of a new paragraph under Article 1 of the Delegated Directive (EU) 2017/593;
(ii) amends the text of the previously proposed amendment to the first sub-paragraph of paragraph 9 of Article 9 of the Delegated Directive (EU) 2017/593, which now reads as follows (additions/changes in bold): “Member States shall require investment firms to identify at a sufficiently granular level the potential target market for each financial instrument and specify the type(s) of client with whose needs, characteristics and objectives, including any sustainability related objectives, the financial instrument is compatible. As part of this process, the firm shall identify any group(s) of clients with whose needs, characteristics and objectives the financial instrument is not compatible, except where financial instruments consider sustainability factors. Where investment firms collaborate to manufacture a financial instrument, only one target market needs to be identified.”
(iii) amends the text of the previously proposed replacement of the eleventh paragraph of Article 9 of the Delegated Directive (EU) 2017/593, which now reads as follows (additions/changes in bold): “Member States shall require investment firms to determine whether a financial instrument meets the identified needs, characteristics and objectives of the target market, including by examining the following elements: (a) the financial instrument's risk/reward profile is consistent with the target market; (b) the financial instrument's sustainability factors, where relevant, are consistent with the target market; (c) the financial instrument design is driven by features that benefit the client and not by a business model that relies on poor client outcomes to be profitable.”
(iv) In order for a manufacturer to disclose sustainability factors of the financial instruments in a transparent way that allows investment firms to engage in dialogue with clients, a new second sub-paragraph under paragraph 13 of Article 9 of the Delegated Directive (EU) 2017/593 has been added as follows: “The sustainability factors of the financial instrument shall be presented in a transparent manner and provide distributers with the relevant information to duly consider any sustainability related objectives of the client or potential client.”;
(v) amends the text of the previously proposed replacement of the fourteenth paragraph of Article 9 of the Delegated Directive (EU) 2017/593, which now reads as follows (additions/changes in bold): “Member States shall require investment firms to review the financial instruments they manufacture on a regular basis, taking into account any event that could materially affect the potential risk to the identified target market. Investment firms shall consider whether the financial instrument remains consistent with the needs, characteristics and objectives, including any sustainability related objectives, of the target market and if it is distributed to the target market, or reaches clients with whose needs, characteristics and objectives the financial instrument is not compatible.”
(vi) amends the text of the previously proposed replacement of the first sub-paragraph of paragraph 2 of Article 10 of the Delegated Directive (EU) 2017/593, which now reads as follows (additions/changes in bold):
“Member States shall require investment firms to have in place adequate product governance arrangements to ensure that products and services they intend to offer or recommend are compatible with the needs, characteristics, and objectives, including any sustainability preferences related objectives, of an identified target market and that the intended distribution strategy is consistent with the identified target market. Investment firms shall appropriately identify and assess the circumstances and needs of the clients they intend to focus on, so as to ensure that clients' interests are not compromised as a result of commercial or funding pressures. As part of this process, investment firms shall identify any group of clients for with whose needs, characteristics and objectives the product or service is not compatible except where financial instruments consider sustainability factors.”
(vii) amends the phrase “sustainability preferences” with “sustainability related objectives” in the text of the previously proposed replacement paragraph 5 of Article 10 of the Delegated Directive (EU) 2017/593:
(viii) amends the transposition date for the national application of the provisions of the Adopted Commission Delegated Directive from twelve months to fifteen months after the entry into force of the Adopted Commission Delegated Directive.
2. Commission Delegated Regulation amending 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 (the “Adopted Commission Delegated Regulation”)
In a comparative analysis between the Initial Commission Delegated Regulation and the Adopted Commission Delegated Regulation, the latter:
a) amends the definition of “sustainability preferences” which was previously proposed to be added as point (7) under Article 2 of the Delegated Regulation (EU) 2017/565, which now reads as follows (additions/changes in bold):‘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; (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; (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;
b) amends the text of the previously proposed replacement of the third paragraph of Article 52 of the Delegated Regulation (EU) 2017/565, which now reads as follows (additions/changes in bold): “Investment firms shall provide a description (to their clients or potential clients when advising them) of: (a) the types of financial instruments considered; (b) the range of financial instruments and providers, analysed per each type of instrument according to the scope of the service; (c) where relevant, the sustainability factors taken into consideration in the selection process of financial instruments; (d) when providing independent advice, how the service provided satisfies the conditions for the provision of investment advice on an independent basis, and the factors taken into consideration in the selection process used by the investment firm to recommend financial instruments, including risks, costs and complexity of the financial instruments.”;
c) amends the text of the previously proposed replacement of the fifth paragraph of Article 54 of the Delegated Regulation (EU) 2017/565, which now reads as follows (additions/changes in bold): “The information about the investment objectives of the client or potential client shall include, where relevant, information about the length of time for which the client wishes to hold the investment, his or her preferences regarding risk taking, his or her risk tolerance, the purpose of the investment and in addition his or her sustainability preferences.”;
d) replaces paragraph 10 of Article 54 of the Delegated Regulation (EU) 2017/565, which now reads as follows: “When providing the investment service of investment advice or portfolio management, an investment firm shall not recommend or decide to trade where none of the services or instruments are suitable for the client. An investment firm shall not recommend financial instruments or decide to trade such instruments as meeting a client’s or potential client’s sustainability preferences when those financial instruments do not do meet those preferences. The investment firm shall explain to the client or potential clients the reasons for not doing so and keep records of those reasons. Where no financial instrument meets the sustainability preferences of the client or potential client, and the client decides to adapt his or her sustainability preferences, the investment firm shall keep records of the decision of the client, including the reasons for that decision.”;
e) adds a new paragraph 13 under Article 54 of the Delegated Regulation (EU) 2017/565 as follows: “The requirements to meet the sustainability preferences of clients or potential clients, where relevant, shall not alter the conditions laid down in the first subparagraph.”.
To be noted that both the Adopted Commission Delegated Directive and Regulation will have to be approved by the European Council and the European Commission before being published in the European Union’s Official Journal and becoming law. The delegated acts give twelve months for financial market participants to implement the requirements and are expected to take effect from October 2022.
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