Compliance Briefing — August 2, 2022
MiFID II firms must now capture and honour client sustainability preferences, aligning product data, governance, and outcome testing with EU Taxonomy, SFDR, and PAI criteria.
Executive briefing: On 2 August 2022 amendments to the EU MiFID II Delegated Regulation came into force, requiring investment firms to integrate clients’ sustainability preferences into suitability assessments. The new rules, stemming from Delegated Regulation (EU) 2021/1253, obligate firms to collect, record, and act upon preferences related to EU Taxonomy-aligned investments, Sustainable Finance Disclosure Regulation (SFDR) Article 8/9 products, and Principal Adverse Impact (PAI) considerations. Firms must overhaul governance, product governance, data management, and outcome testing to evidence that recommendations align with declared sustainability preferences.
Regulatory scope and expectations
The amendments apply to investment firms providing investment advice or portfolio management to retail and professional clients. Firms must:
- Update suitability questionnaires to capture whether clients desire investments that contribute to environmental objectives under the EU Taxonomy, qualify as SFDR Article 8 or 9 products with minimum sustainable investments, or consider PAIs on sustainability factors.
- Map sustainability preferences to product characteristics, ensuring the product universe is appropriately labelled and supported by reliable data.
- Document processes for resolving mismatches between client preferences and available products, including explaining trade-offs or recommending preference adjustments where necessary.
- Maintain records demonstrating how recommendations or portfolio allocations fulfil sustainability preferences.
Supervisors expect firms to avoid “greenwashing” by ensuring sustainability claims are substantiated and that client communications are clear and fair.
Governance and control framework
Firms should enhance governance through:
- Board oversight. Integrate sustainability preference compliance into conduct risk and ESG governance forums.
- Policies and procedures. Update suitability, product governance, conflicts of interest, and disclosure policies to reflect sustainability preference integration.
- Training. Provide advisers and portfolio managers with training on EU Taxonomy criteria, SFDR classifications, and data interpretation.
- Compliance monitoring. Implement periodic testing of advice files, client portfolios, and disclosures to confirm adherence to preferences.
Internal audit should include sustainability preference integration in its multi-year plan, assessing control design and effectiveness.
Data management and technology
Reliable sustainability data is central to compliance. Firms must ensure:
- Access to verified data on EU Taxonomy alignment, SFDR sustainable investment proportions, and PAI indicators, sourced from issuer reports, data vendors, or internal models.
- Data governance processes covering data lineage, validation, and reconciliation with regulatory disclosures.
- Systems capable of matching client preferences to product attributes and generating alerts when portfolios drift from preferences.
- Documentation of assumptions, proxies, or estimations used when data is incomplete, with plans to refine as CSRD reporting becomes available.
Outcome testing should verify that data feeds remain current, that matching algorithms function as intended, and that exceptions are investigated promptly.
Outcome testing and evidence
Firms must demonstrate that sustainability preferences are respected. Testing may include:
- Reviewing samples of suitability reports to confirm that recommended products meet stated preferences and that justifications are documented.
- Analysing portfolio holdings to ensure minimum thresholds for sustainable investments or Taxonomy alignment are achieved.
- Monitoring PAI indicators to confirm they do not breach client-defined tolerances.
- Surveying clients on understanding of sustainability disclosures and satisfaction with recommendations.
- Tracking complaints related to ESG claims or misalignment.
Firms should maintain dashboards for senior management summarising adherence rates, exceptions, remediation actions, and trends.
Product governance implications
Manufacturers must document target markets, sustainability features, and data sources for each product. Distributors need timely access to this information to perform matching. MiFID product governance reviews should incorporate:
- Assessment of whether products deliver stated sustainability outcomes.
- Evaluation of ongoing data quality, including verification of third-party ESG ratings and controversies monitoring.
- Controls ensuring marketing materials accurately reflect sustainability characteristics.
Where products fall short, firms must take corrective action, such as adjusting investment strategies, updating disclosures, or withdrawing products.
Client communications and disclosures
Advisers must explain sustainability preference options in clear language. Pre-contractual and periodic disclosures should set out how preferences are met, including quantitative metrics (e.g., percentage of Taxonomy-aligned investments) and narrative explanations of PAI mitigation. Firms should provide clients with ongoing reporting on progress against sustainability objectives, including any adjustments made.
Interaction with other regulations
The sustainability preference requirements intersect with SFDR, EU Taxonomy disclosures, the Insurance Distribution Directive (IDD) for insurance-based investment products, and forthcoming CSRD reporting. Firms should align data and governance to avoid duplication and ensure consistency across disclosures.
Implementation roadmap
- Immediate (August–October 2022): Update questionnaires, systems, and data feeds. Train advisers and test suitability workflows.
- By year end 2022: Complete first round of outcome testing, remediate issues, and refine MI dashboards. Coordinate with product manufacturers for data sharing.
- 2023 onward: Integrate CSRD-derived data, enhance automation, and expand analytics to measure impact investing outcomes. Prepare for supervisory reviews and thematic inspections.
Sources
- Commission Delegated Regulation (EU) 2021/1253
- ESMA public statement on sustainability disclosures
- ESMA supervisory briefing on sustainability risks and disclosures
- European Commission guidance on sustainability preferences
- EBA opinion on sustainability-related compliance
Zeph Tech assists EU investment firms with integrating sustainability preferences into suitability processes, data governance, and outcome monitoring to satisfy MiFID II and SFDR expectations.
Integrating stewardship and engagement
Honouring sustainability preferences extends beyond portfolio construction. Firms should document stewardship strategies that use voting and engagement to pursue client objectives. This includes recording engagement themes, outcomes, and escalation steps when investee companies do not respond. Linking stewardship KPIs to client preferences can demonstrate progress even when suitable products are scarce. Firms should provide clients with periodic stewardship reports covering engagements tied to Taxonomy objectives or adverse impacts addressed, showing alignment with their stated priorities.
Outcome testing should evaluate whether stewardship efforts lead to measurable changes, such as improved disclosure scores, emissions reductions, or governance reforms. Compliance teams can sample engagement cases, verify documentation quality, and confirm that outcomes are communicated back to clients.
Scenario analysis and impact reporting
Advanced firms are using scenario analysis to illustrate how portfolios aligned with sustainability preferences perform under climate transition or social disruption scenarios. By modelling temperature pathways, carbon price shocks, or human rights controversies, advisers can show clients the implications of their choices. Impact reporting dashboards can quantify contributions to Sustainable Development Goals, financed emissions trajectories, or improvements in PAI indicators. These tools require robust data and should be validated by independent assurance providers where possible.
Lessons from early supervisors
Several national competent authorities (NCAs) have begun thematic reviews. The French AMF and Dutch AFM have highlighted gaps in how firms explain preference options, manage data quality, and evidence ongoing alignment. Early findings emphasise the need for internal audit involvement, documentation of decision-making, and transparent communication when preferences cannot be fully met. Firms should monitor supervisory statements and adapt controls accordingly.
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