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This article explains how the FCA want you to change your approach to ESG investing.

by Jill Chadburn on 19·05·2020


The UK’s new target to reach net zero greenhouse gas emissions by 2050 means the UK are the first major economy in the world to set such a target into law.


The international community is beginning to take the kind of action that a challenge like this demands.  The result will be a significant transformation towards cleaner, more resilient economic growth.


As the financial risks and opportunities from the low carbon transition become apparent, a second, equally important, transformation is also underway: that of the financial system, and that is where everybody in financial services is going to be affected.


The transition to a green financial system means fundamental changes to the way decisions are made across the economy.


In May 2018 the European Securities and Markets Authority (ESMA), proposed changes to Mifid II to bring financial advice firms into line with the EU’s climate action plan through the integration of sustainability and ESG (Environmental, Social and Governance) considerations.


The European Commission (EC) stated that “by providing advice, investment firms and insurance distributors can play a central role in reorienting the financial system towards sustainability.


The FCA have indicated that they will be implementing these rules and making the required changes to COBS irrespective of Brexit.  The regulator in the UK will seek to mirror European initiatives in this area, otherwise there would be significate issues for selling product and financial services in Europe.


At the moment, advisers are required to assess clients' investment objectives and risk tolerance in order to recommend suitable financial instruments or insurance products. However, investors' and beneficiaries' preferences as regards sustainability are often not sufficiently taken into account when advice is given.


The proposed amendments to the Mifid II requirements go beyond asking the ESG question. They require advisers to demonstrate they have a process in place should a client have an ESG preference.


At The Timebank, we have been anticipating this and have been building this into the CIP documentation, Due Diligence and PROD work we are doing.  Ultimately, it is better to have it and not need it than need it and not have it.  This is especially important if it is the FCA asking if you have it!


So, what’s the difference between sustainable and ethical investing? The simplest way to explain it is that ethical investing focuses on negative screening and avoidance, whereas sustainable investing is about positive selection and positive screening.


Sustainable investing lets investors embed their values into their investments. Sustainable investing looks to invest in companies that have socially useful products and services, and that lead their industries on environmental, social and governance management - all with a strong focus on delivering investment returns.


The process will need to show how ESG funds are identified and how the advisers assesses one against another to ensure they can put together the appropriate products and funds to meet each client’s needs.


Firms should have appropriate arrangements in place to ensure that the inclusion of ESG considerations in the advisory and portfolio management processes does not lead to mis-selling practices. This includes using ESG as an excuse to sell a firm’s own products, or more costly products, or to generate churning of clients’ portfolios, or to misrepresent products or strategies as fulfilling ESG preferences where they do not.


Under the current proposals, a new disclosure regulation will require advisers to report the extent to which sustainability risks are expected to impact investment returns to clients.


Product manufacturers and distributors should also take ESG preferences and considerations into account when identifying target markets for the financial instruments they manufacture or distribute.  PROD is here now, and has been for a couple of years.  This is one of the central pillars of what PROD is trying to achieve.


The proposals are still under negotiation and remain subject to change, but they are expected to come into effect in approximately 12-18 months.


You should start thinking about ESG now and below are some of the areas for you to consider:


  • How advisers will explain the new ESG concepts, features of products or services recommended to new clients and to existing clients as pat of the ongoing reviews.
  • Processes need to be put into place to show how the firm plans to record their client’s ESG preferences and how the company will take these into account during the advice process.
  • Review the firms Centralised Investment Proposition to ensure that existing fund, platform and DFM recommendations are able to meet stipulated ESG preferences of clients.


At The Timebank (UK) Ltd one of the services we currently offer our adviser firms is to complete your Centralised Investment Proposition for you, based on your clients’ needs and requirements, so if you feel lost we can help you.