A number of disruptive changes are currently affecting the fund industry, not least of which is the rise of sustainable finance. How can it be that everybody is talking about sustainable finance as the future of the industry, but that such a small proportion of retail investors are actually buying sustainable products?1 Could this all be a distribution issue?

Over the past 10 years, sustainable finance has been very much looked at through the prism of both asset managers and institutional investors; however, the debate largely missed out the very end of the investment chain before the client itself—the financial advisor, the one actually giving investment advice.

Under the existing MiFID II framework, firms providing investment advice and portfolio management are required to obtain the necessary information about the client’s knowledge and experience in the investment field so as to provide services and products that are suitable for the client. While this suitability assessment generally relates to financial objectives, it does not address the non-financial objectives of the client, such as environmental, social, and governance (ESG) preferences.

This is about to change as, in its final recommendations report, the HLEG2 has specifically requested that investment advisers "ask about, and then respond to, retail investors' preferences about the sustainable impact of their investments, as a routine component of financial advice.”

In response to this, the European Commission has launched a consultation process to assess how best to include ESG considerations in the advice that investment firms and insurance distributors offer to individual clients. The idea is to amend delegated acts under MiFID II and IDD3 so as to better address non-financial considerations in financial advice.

Now comes the trickiest question—how can financial advisors assess the ESG preferences of their clients? The questions we are asking clients are a good place to start. If you pose the question "Are you interested in sustainable investing?" then the answer is likely to be a resounding "yes." A 2017 study carried out by Morgan Stanley4 shows that 75% of individual investors are interested in sustainable investing, with a higher rate of 86% among millennials.

But of course, reality is a little more complex than that. Sustainable investing comes in many different shapes and forms—the strategies and end objectives are as diverse as you can imagine. They can range from excluding certain sectors or assets to using voting rights; from integrating all sorts of ESG criteria, to even measuring the real ESG impact of portfolios. It is a maze of terminologies and I suspect that some sustainable finance experts enjoy maintaining the confusion.

However, as time is money, purchasing decisions are taken fast, especially online. Customers compare funds in the same way as one might compare hotels when planning a holiday: they look at a range of criteria in line with their suitability preferences. Retail investors do not have the time, and may even not be willing, to understand all the breadth and depth of sustainable finance, and what the various categorisations mean.

Don't get me wrong. The European Commission has ambitious plans that will also help move the situation forward, for which they must be applauded. Coming up with a taxonomy to categorise what should be considered as green or sustainable would be one of the most courageous (and necessary) moves ever taken by the Commission. It would not only force asset managers to be clearer about the status of their funds, but also allow investors to check whether the invested assets are truly sustainable, and if so, in what way. However, the risk is that the terms chosen are as confusing to the investor as the present system is. Would your average customer really know what to answer if asked whether they would like to invest in a fund that pursues "an ESG integration strategy," or a fund that "follows a 'Best in Class' approach"?

So what is the answer? I think we need to move away from trying (and often failing) to explain what sustainability is, and move towards real clarity. Let's keep it simple, as they say. Questions could then be: is there a specific sector which you do not want to invest in? Would you prefer to invest in sectors like renewable energy, affordable housing, or infrastructure? Do you prefer to invest in funds that are listed on a dedicated green exchange? Would you like them to hold a quality label? Do you prefer funds that will report on the non-financial aspects of your investment, like social impact?

This would, I believe, facilitate the work of financial advisors and remove the subjectivity and confusion that arise under the current system.

In a nutshell, the less subjective the questions are, the better. Moving to this new model, however, will require changes from all stakeholders. Investment managers will have to provide easy-to-understand and straightforward extra-financial data (not tons of CO2 equivalents that the investors do not understand). Information providers will need to adapt their databases to include additional fields, and financial advisors will need to improve their knowledge of ESG funds. Last but not least, the European Commission will need to provide robust technical guidance so that suitability questionnaires related to ESG preferences are standardised across member states.


1 The HLEG report highlights that "Despite their rapid growth, ESG funds represent less than 2% of the overall European retail funds market," p27, HLEG Final Recommendations report, 30 January 2018

2 High Level Expert Group from the European Commission

3 Insurance Distribution Directive

4 Sustainable Signals, Morgan Stanley institute for sustainable Investing, August 2017, which surveyed 1,000 individual investors in the US

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