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Wealth managers may be failing new MiFID II suitability test

Euro bills representing investment.

New EU rules regarding ESG and sustainability preferences require all investment firms to include these preferences when recommending investments to their clients. Research from Oxford Risk shows that almost half of the investors had never been consulted on ESG and responsible investing preferences by wealth managers.

An investor survey conducted by Oxford Risk found that almost one-third felt their wealth manager did not address their ESG preferences, while almost half said they had never consulted on the matter. 

Suitability is an important compliance requirement for wealth managers, attracting supervisory and regulatory scrutiny in any jurisdiction. The new MiFID II requirement to consider clients’ ESG and sustainability preferences will add to this scrutiny.

The survey results add to existing concerns over greenwashing, making it more difficult for firms with innovative technologies and good energy transition plans to attract the appropriate investor attention. 

A key takeaway of the survey was that advisors and wealth managers may be missing out on a golden opportunity by not engaging with investors on their sustainability and ESG preferences.   

Survey results show wealth managers falling short of meeting suitability requirements

A failure to discuss investor preferences falls short of suitability requirements, which is a big compliance red flag from regulators in most developed markets. The requirement to do so when considering ESG and sustainable investments became part of MiFID II on August 2, 2022, and will likely add to this scrutiny, given the rate at which that market is growing.

Only 37% of investors said that their own portfolio adequately reflected their sustainability views, while 31% said they would invest more if their portfolios better reflected these views. Almost half (46%) stated they had never been contacted by their wealth manager to discuss their attitude to ESG investing.

Consulting on ESG with clients would therefore meet the compliance requirement, and result in more funds being invested. 

The survey also found responses that differed along demographic lines, with almost 60% of investors under 35 saying they would invest more money in portfolios that had a higher sustainability weighting. 

Definitions, compliance and the fear of greenwashing

The research by Oxford Risk mentions the difficulty in assessing investor attitudes towards sustainable investing, given the multiple and varying definitions of the asset class. Ranging from impact and exclusions-based investments, to those that focused on ESG factors, Oxford discusses how definitions can muddy the waters for investors.

ESG investing itself has been the cause of increasing backlash from affected companies, investment management firms, and even jurisdictions pushing back on regulation. Amid this confusion, investors are also faced with investment choices that could be guilty of greenwashing. 

For companies this could be unsubstantiated claims relating to sustainability and transition plans, and for funds it could extend to labelling without adequate checks. Many ETFs and funds have been stripped of their ESG labels for falling short of listing criteria.

Another challenge identified with ESG investing is the bundling together of environmental, social and governance issues. A person that places a higher value on environmental impacts over social or governance issues, may not be well served by a rating system which combines all three, adding further complexity to the selection process for both advisors and investors. 

The unabated rise in fund flows into sustainable/responsible/ESG investing assets, despite market headwinds seen in 2022, demonstrates the strength of this segment of the market. Matching investor preferences with compliant and quality sustainable investment choices will remain the challenge that advisors and wealth managers confront, and regulatory frameworks continue to evolve.

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