New MiFiD ESG requirements poses challenges

From Best Execution:

The new MiFiD II requirements that recently came into force, making it mandatory for advisers to ask investors about their sustainability preferences, will be a challenge, according to Morningstar.

For those clients interested in investing sustainably, advisers will now have to source products that have a minimum proportion of sustainable investments, as defined by the Sustainable Finance Disclosure Regulation (SFDR) or EU Taxonomy.

To make the product selection process easier for advisers, asset managers have to disclose information through a new European ESG template (EET).

The EET was  developed by industry consortium Financial Data Exchange Templates (FinDatEx) to facilitate the exchange of data between product manufacturers and distributors across the financial services sector to provide a regulatory overview.

The template comprises a total of 580 mandatory, conditional and optional fields, with additional country-specific requirements making things more complex at a fund and underlying individual share class level.

Data from FE fundinfo shows that fund managers are “still grappling” with this challenge, with with more than half of those surveyed yet to submit the required data nefore the 2 August deadline,

One of the main problems, according to Morningstar, is with asset managers reporting a fund’s exposure to sustainable investments and classification under the taxonomy.

This is mainly due to the well documented conundrum of issuer data availability as well as a definitional problem.

Under the SFDR, a sustainable investment is one “that contributes to an environmental or social objective, provided that such investments Do Not Significantly Harm any of those objectives and that the investee companies follow good governance practices”.

However, as Morningstar notes, the issue is that this definition of “sustainable investment” leaves too much room for interpretation, especially when it comes to the Do Not Significantly Harm (DNSH) principle.

A list of Principle Adverse Impact indicators must be considered for the purpose of the DNHS test. These indicators are a series of metrics in relation to certain matters, such as “greenhouse gas emissions” and “water usage and recycling”.

Regulators, though, haven’t specified any thresholds, so determining what these should be is currently left at the discretion of asset managers, according to Morningstar.

The data provider said that another aspect left at the discretion of managers relates to the way sustainable companies are counted in portfolios.

While one firm might count the entirety of a sustainable company  beyond a certain level of revenue derived from sustainable activities, another might only count the proportion of revenue attributed to those activities.

These two approaches would produce opposite results: high percentages of sustainable investments in the first case, and much lower levels in the latter case.

Morningstar said that different interpretations of the regulation have led asset managers to adopt different approaches to the calculation of sustainable investment exposure, rendering it impossible to compare competing products directly.

Products with similar mandates and portfolios will report divergent exposures to sustainable investments depending on the methodology chosen by their providers.

“Much of the sustainability data and criteria needed to comply with the suitability requirements under the MiFID II update is the same as that housed already for the EU SFDR and the green taxonomy,” said Janine Hofer-Wittwer, CFA, senior product manager, financial information, SIX.

She added, “For market participants, the goal is to work with data providers able to source and distil the data and provide it in a way that is easy to implement, minimising the lift needed for the latest and future ESG regulatory requirements.”

Kifaya Belkaaloul, head of regulatory, NeoXam said, “With these imminent amendments to MiFID II, fund managers need to provide ESG data in a standardised format for all products marketed in the EU to fund distribution channels so that the distributors can evaluate the end client sustainability preferences.

This is an important change – ESG data is not only a vital part of the investment process, but also essential in adding weight to sustainability claims.”

The challenge this presents is that it requires firms to pull ESG data from multiple disparate sources, efficiently into a new format. Ultimately, the firms who have a solid data architecture in place are those whose reporting houses will stand solid against the winds of regulatory change.”

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