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More ESG from the EU: updates to the MiFID Regime

  • United Kingdom
  • Europe
  • Financial services and markets regulation - ESG
  • Financial services and markets regulation - MiFID
  • Financial services



As part of its Action Plan on sustainable finance announced in March 2018, the European Commission has published a draft of sustainability legislation. We have been discussing this legislation and its impact on firms and fund managers as part of a series of briefings and have so far covered:

In recent months the EU has published further draft regulations which amend the familiar MiFID II, AIFMD and UCITS regimes, in order to integrate ESG considerations into firms’ behind the scenes policies and procedures. In this briefing we will cover the impact of “ESMA’s technical advice to the European Commission on integrating sustainability risks and factors in MiFID II” (“ESMA’s technical advice”), published on 30 April 2019.

ESMA’s technical advice has been adapted into a number of draft delegated regulations. The changes relevant to MIFID II are addressed in “Draft COMMISSION DELEGATED REGULATION (EU) of XXX 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 “Draft Delegated Regulation”), published on 8 June 2020.

The proposed changes to the AIFMD and UICTS regimes are covered in our client briefing “More ESG from the EU - updates to the UCITS and AIFMD Regimes”.

Following the publication of the Draft Delegated Regulation, it is expected that the final legislation will be introduced at the end of 2020 or early 2021 allowing for the European Parliament and Council objection period.

Proposed MiFID II Changes

The current MiFID rules on suitability require financial professionals to obtain information about a client’s knowledge regarding investments and assess their risk profile in order to recommend products suitable to the client. Crucially, however, non-financial objectives are not considered. The European Commission found that the existing suitability assessments, therefore, usually do not include ESG issues and the majority of clients did not raise these issues themselves. This means the firms do not consistently factor ESG issues into their processes.

The Draft Delegated Regulation amending MIFID II Delegated Regulation 2017/565 will require firms to integrate ESG considerations and preferences into both portfolio management and how investment advice is given. In particular, the Draft Delegated Regulation proposes amendments to Article 52 (information about investment advice) and Article 54 (assessment of suitability and suitability reports) of the MiFID II Delegated Regulation. The proposed amendment to Article 52(3) would require a MiFID II investment firm to include ESG considerations when providing a description of the factors taken into consideration in the selection process used to recommend financial instruments, where relevant, in addition to other factors already set out in Article 52(3) such as the risks, costs and complexity of financial instruments.

ESMA Report on MiFID II Changes

ESMA’s technical advice considered how the existing MiFID II regime should be further modified to address ESG issues and recommended certain changes, which are reflected in the Draft Delegated Regulation. ESMA noted that the market had not yet reached maturity and they did not want to put the EU at a disadvantage by creating “overly prescriptive norms”, so they stressed the proportionality principle.

Their report suggested the following changes to the MiFID II Delegated Regulation:

General Organisational Requirements (Article 21(1) of MiFID II Delegated Regulation)

A further requirement to incorporate sustainability risks within the existing requirements set for investment firms' internal organisation, including firms' processes, systems and controls; risk management functions; and processes to eliminate conflicts of interest. The Disclosure Regulation, part of the package of EU measures, defines sustainability risk as: " environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment arising from an adverse sustainability impact" and the report makes clear the same definition is to be used for these purposes.

Risk management (Article 23 of MiFID II Delegated Regulation)

ESMA decided it was appropriate to include a specific obligation to take sustainability risk into account in firms’ risk management policies and procedures. However, they decided to recommend a new recital on risk management that was not proposed at the consultation stage, but which does confirm ESMA’s view expressed in the consultation paper that both compliance and internal audit must consider sustainability risks. The recital also refers to senior management aligning ESMA’s advice on UCITS/AIFMD with that on MiFID (discussed below).

Conflicts of interest (Recital of MiFID II Delegated Regulation)

ESMA decided to recommend a new two-pronged recital to be added to the MiFID II Delegated Regulation to ensure that investment firms:

  • when identifying the types of conflicts of interest that may damage the interests of a client, include those that may stem from the distribution of sustainable investments; and
  • establish “appropriate arrangements” to ensure that inclusion of ESG considerations in advisory and portfolio management processes does not lead to mis-selling.

The recital gives three examples of the types of mischief in mind:

  • an excuse to sell own-products or more expensive ones;
  • churning of clients’ portfolios; or
  • misrepresentation of products or strategies as fulfilling ESG preferences when they do not (“greenwashing”).

Firms will be expected to revise their conflicts policies to include the identification and management of these types of conflict.

Product governance (Articles 9(9), 9(11), 9(14) and 10(2) and 10(5) of the MiFID II Delegated Directive)

With particular reference to manufacturers’ and distributors’ obligations on the definition and review of the target market, ESMA proposed a high-level requirement on firms (allowing flexibility) to consider their clients’ “ESG preferences (where relevant)” and whether any financial instrument’s “ESG characteristics (where relevant) are consistent with the target market”.

In a subtle but significant change, ESMA amended its consultative wording that held out clients’ and target markets’ ESG preferences as an example of their “needs, characteristics and objectives” in favour of characterising them as a self-standing factor. This was to differentiate between investment objectives and ESG preferences, which the Commission regards as important in order to avoid any mis-selling where an ESG consideration ranks above a client’s own investment objective.

Next steps

If adopted, the changes will require MiFID II investment firms, UCITS management companies and AIF managers to make changes to ensure that consideration of ESG factors and risks is part of their processes, and to reconsider their disclosures to ESMA and investors. Those firms which manage or market financial products or services with a “sustainable” target or investment strategy will be impacted most, but ultimately all firms should be aware of these changes.

ESMA notes in its report that the proposed reforms are intended to ensure that Senior Management is made collectively responsible for integrating consideration of sustainability risks. In practice (and particularly for UK managers, who will need to take the SMCR into account) this will mean ensuring that senior management:

  • has a good grasp of the firm's policy in relation to sustainability issues (this might require board and employee training);
  • receives the necessary information regarding steps to comply with its sustainability policy;
  • understands key ESG developments which might affect their business;
  • takes leadership on sustainability issues where necessary; and
  • ensures the business are actively engaging with companies on ESG topics.

Although the legislation is yet to come into force, firms should be reviewing their existing policies now and mapping out what changes will need to be made to their processes.

How can Eversheds Sutherland help?

Our team have been advising on regulatory interpretation and product development for the fund management industry since the 1980s and we were at the forefront of MiFID II implementation. Our in depth understanding of the sector and experience with the practical implementation of ESG (including how screening processes work in practice) mean that we are very well placed to guide you through the implementation process and next steps in order to comply with the new legislation. We can also assist with gap analysis highlighting gaps between your current processes and the new rules.

Find out more on ESG and Sustainable Finance >

The Eversheds Sutherland ESG timeline

Our ESG timeline sets out current and forthcoming initiatives and developments to help you keep abreast of this rapidly evolving area. The timeline includes links to a wealth of materials and our briefings on other aspects of ESG.

View the ESG timeline >