Avaloq co-CEO, Martin Greweldinger, explains how technology can help financial institutions efficiently integrate clients’ ESG preferences into investment advice.

The European Securities and Market Authority (ESMA) concluded its consultation on proposed amendments to MiFID II in April this year, with the EU’s new regulations coming into force on 2 August 2022. The European regulator aims to ingrain environmental, social and governance (ESG) preferences in suitability assessments to strengthen investor protection and promote sustainable investing.

Under the new regulation, financial institutions will need to proactively assess their clients’ sustainability preferences in the same way that risk tolerance and investment knowledge are measured currently.

Passive Sustainability Offerings no Longer Enough

Sustainability based on ESG criteria is a fast-growing investment theme, driven by investor demand and regulatory forces. Most financial institutions already offer their clients access to sustainable funds and products; however, the onus is often on investors to ask about these offerings and to specifically request them.

Sustainability preferences will soon comprise a routine component of the investor profile. The upcoming amendment to MiFID II not only requires a cultural shift within the industry, but financial institutions will also need to apply an ESG classification system – based on regulation as well as industry standards such as EET (European ESG Template) – to create a list of environmentally sustainable products and define how these products align with investor preferences.

The trend within the industry and among regulators is clearly moving towards a greater focus on sustainability, so it’s imperative that financial institutions adopt these new regulations by the August deadline or risk trailing behind their competitors and potentially running afoul of regulators further down the line.

Technological Solution to ESG Investing

ESG investing is as much a technological challenge as it is an ethical imperative. Even the best value proposition can fall short of the mark if the technology behind it is not up to scratch – and the same applies when incorporating new guidance from regulators.

To ensure that the new regulation is implemented rapidly and effectively, financial institutions should check that their current investment platforms are able to guarantee compliance with changing regulations for EU-based clients while supporting ESG investment products that cover both discretionary and advisory mandates.

A state-of-the-art ESG solution should incorporate investors’ preferences based on the Principle of Adverse Impacts (PAI), define minimum allocations of sustainable investments in line with the defined taxonomy objectives, and classify sustainable investments in accordance with the Sustainable Finance Disclosure Regulation (SFDR).

These sustainability preferences should be applied across the entire investment advisory and portfolio management process. The solution should be able to model suitability rules and automatically collate ESG data from trusted sources, such as MSCI. 

The easiest way for financial institutions to meet these new requirements is to add an ESG layer on top of their existing framework for determining investor suitability – with an expanded investor questionnaire, the addition of standard ESG ratings and new exclusion criteria.

The Path to ESG Leadership

This changing regulatory landscape will give ESG investing a much-needed overhaul and align it with the preferences and expectations of investors – especially younger cohorts, who are the high-net-worth clients of tomorrow. But it is also an opportunity for financial institutions to position themselves as leaders and first movers in sustainability instead of simply playing compliance catch-up.

Taking a proactive approach and implementing a robust technological solution to respond to this new regulation rapidly can boost the reputation and sustainability credentials, which will be vital for client acquisition and retention in the future.

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