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BNP Paribas Asset Management: MiFID II and ESG preferences: A paradigm change in Europe?

The revision of the European Union’s MiFID II directive taking effect this August and requiring investment firms to assess clients’ sustainability preferences sets a regulatory priority that will impact asset management professionals in 2022 and beyond.

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The revision of the European Union’s MiFID II directive taking effect this August and requiring investment firms to assess clients’ sustainability preferences sets a regulatory priority that will impact asset management professionals in 2022 and beyond.

As of 2 August, financial product advisers and distributors will have to ask clients to specify their sustainability preferences. This is part of the European agenda to direct capital to companies most active in the transition to a low carbon and inclusive economy.

We believe this regulation is a powerful accelerator that empowers investors and improves transparency in a particularly dense regulatory environment where the fight against greenwashing is omnipresent.

Towards a more ‘tailored’ portfolio construction

Putting the client at the centre of the process by allowing them to express their investment choices will lead to greater portfolio customisation, but also allow for a more harmonised Environmental, Social & Governance (ESG) product offering.

The MiFID questionnaire used to harvest the investment preferences and determine product suitability will be key. It concerns environmental, social and governance criteria, product alignment with the European taxonomy and ‘negative investment externalities’.

Investor responses will have to be translated into a concrete product offering. This ‘à la carte’ model presents a major challenge: Aligning the preferences with fund characteristics.

Each distributor must draw up a questionnaire. Regulators will nonetheless be vigilant when it comes to interpreting the legislation: The European Securities and Markets Authority (ESMA) has recently clarified this point by providing the first elements of a prescriptive framework. We see this as a welcome initiative that should lead to harmonised questionnaires.

The new challenges for asset managers

In this new paradigm, the asset management industry plays a critical role: That of proposing a complete offering corresponding to the entire range of investor profiles, not only in terms of ESG preferences, but also risk appetite, portfolio diversification, liquidity, etc.

Asset managers must ensure that the funds proposed align with the expectations defined by clients and distributors. In line with the stated objectives, funds will have to either: 

  • Limit negative impacts such as greenhouse gas emissions or gender wage inequality
  • Integrate a proportion of assets defined as ‘sustainable’
  • Be in line with the European taxonomy goals such as climate change mitigation and ecosystem protection. 

Currently, BNP Paribas Asset Management’s offering includes a product range integrating ESG criteria with more than EUR 330 billion in assets under management (end December 2021) covering a broad set sectors and geographies.

The introduction of MiFID 2 rules should make sustainable funds even more attractive, but we will have to ensure that we maintain a balanced allocation of capital to avoid excessive concentration of investments.

Data – An essential first step

In line with investor enthusiasm for sustainable finance, European regulators are intensifying their efforts and involving all stakeholders.

After the introduction of MiFID II, ‘level 2’ regulatory technical standards will apply from 1 January 2023. These will provide a strong framework as to how asset managers communicate on so-called Article 8 and 9 funds under the SFDR regulation. Next, the Corporate Sustainability Reporting Directive (CSRD) directive, still under discussion, aims to strengthen companies’ financial and ESG reporting obligations from 2024.

While we welcome the progress resulting from this regulatory framework, the order of the regulations could have been better: If first companies disclose their ESG data in a transparent and harmonised way, asset managers can use them in the construction of their fund offerings, and finally distributors can assess investor preferences for sustainable investments.

This sequence requires us to collect extra-financial data from companies by other means. At BNPP AM, we have been using our proprietary scoring methodology since 2018, covering more than 13 000 issuers, to gather data on various ESG criteria, which we complete with information from other sources.

Technology – At the heart of MiFID II

To define the optimal portfolio allocation according to an investor’s ESG preferences, technology will be essential to collect and process ESG data, and to ensure that it is properly taken into account in investment strategies.

Technology will also have a prominent role in the offering for clients under MiFID II: Algorithms will make it possible to translate the constraints from the questionnaires into optimal portfolios meeting investor needs.

Finally, technology is also a tool for teaching people. We advocate the use of digital paths, for a streamlined, simplified experience connected to the portfolio construction algorithms.

All this will allow for a better diversified capital allocation and better risk control, aligned with the sustainability challenges.

Looking ahead

In coming years, implementing sustainable finance legislation will be a major project for the financial services industry. We welcome and contribute to regulators’ efforts to increase the transparency of available information, and actively engage with policymakers and governments to help them shape the markets we invest in and the rules that guide and govern corporate behaviour.

There is further to go, not least to improve the quality and access of companies’ ESG data. We are confident that MiFID II and various other regulations will ultimately bring more standardisation to the benefit of clients.

Let us not forget that this represents much more than a new legal framework, it is an important step towards reallocating capital towards the ecological transition and social issues. Like any major upheaval, the transition will take place over time and require the help of all stakeholders: Distributors, asset managers, regulators – and of course investors.

Disclaimer    

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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