MiFID II ESG product governance amendments in force from 22 November 2022

The new product governance amendments will require firms to specifically take into account ESG factors throughout their product governance processes. These amendments will affect all firms and products which are in-scope for MIFID II product governance such as banks arranging and underwriting securities, funds (both levered and unlevered) raising capital and investment managers offering structured products. However these amendments will be particularly impactful for firms providing ESG-focused products such as Green, Social and Sustainability bonds/asset-backed securities and funds with a sustainability-based investment strategy (e.g. investing in real estate with a high ESG score). The amendments are expected to result in enhanced ESG disclosure for such products.  

Background

On 22 November 2022 the last of the ESG-related changes to the MiFID II¹ delegated acts² came into force in the European Union (EU) with the amendments to the product governance rules to incorporate sustainability considerations (Commission Delegated Directive (EU) 2021/1269³ – accessible here). These changes now require MiFID II firms to consider sustainability preferences and consider and disclose sustainability factors in product approval and governance arrangements. The changes apply to both manufacturers and distributors throughout the product lifecycle.

The product governance amendments follow companion ESG-related amendments to the MiFID II suitability assessment provisions (Commission Delegated Regulation (EU) 2021/1253⁴ – accessible here), which came into force on 2 August 2022. The amendments to the suitability assessment provisions require firms to integrate consideration of sustainability risks and factors when conducting suitability assessments for clients.

ESMA guidelines

On 23 September 2022, ESMA published revised guidelines on aspects of the MiFID II suitability requirements to deal with the ESG-related changes.

On 8 July 2022, ESMA issued a consultation for review of, and with proposed ESG-related updates to, its existing guidelines on MiFID II product governance. The consultation period ended on 7 October 2022, and final guidelines are expected from ESMA in Q1 2023.

Product governance and ESG: What do manufacturers and distributors need to do?

Manufacturers and distributors must now consider “sustainability factors”⁵ (i) in their product approval process for each financial instrument and (ii) in the other product governance and oversight arrangements for each financial instrument that is intended to be distributed to clients seeking financial instruments with a sustainability-related profile.

Manufacturers need to do the following:

1. When identifying the potential target market for a product and specifying the types of clients with whose needs, characteristics, and objectives such product is compatible, manufacturers must include “any sustainability related objectives” in their analysis.  However, firms do not have to consider sustainability factors in their negative target market assessments.
2. Manufacturers must present the sustainability factors for a product in a transparent manner and provide distributors with the relevant information they need to consider the sustainability objectives of the client or potential client.
3. In satisfying their periodic review obligations, manufacturers must consider if a product remains consistent with the needs, characteristics, and objectives, which includes any sustainability related objectives, of the target market.

Distributors need to do the following:

1. Distributors must ensure they only offer or recommend products which are compatible with the needs, characteristics, and objectives, including any sustainability related objectives, of an identified target market and that the intended distribution strategy is consistent with the identified target market.
2. In their target market assessments and distribution strategies, distributors must with sufficient granularity specify to which group of clients with sustainability related objectives the financial instrument is supposed to be distributed. However, firms do not have to consider sustainability factors in their negative target market assessments.
3. Distributors must periodically review the products they offer and recommend, ensuring they remain consistent with the needs, characteristics, and objectives, which includes any sustainability related objectives, of the target market.

Conclusion

The MiFID II ESG amendments are useful regulatory developments as the EU seeks to action its Sustainable Finance Action Plan. They put the requirement to consider “sustainability” front and centre for financial products.  However the practical impact of these amendments remains to be seen.

Footnotes

1. Commission Directive (EU) 2014/65 (the MiFID II Directive) together with Commission Regulation (EU) 600/2014 (MiFIR) (together, MiFID II).
2. Commission Delegated Regulation (EU) 2017/565 supplemented the MiFID II Directive and contains organisational requirements and operating conditions for investment firms, including regarding suitability assessments. Commission Delegated Directive (EU) 2017/593 supplemented the MiFID II Directive to provide a detailed list of obligations that manufacturers and distributors, respectively, need to comply with to meet their product governance obligations.
3. Amending Commission Delegated Directive (EU) 2017/593.
4. Amending Commission Delegated Regulation (EU) 2017/565.
5. The new MiFID II definition of “sustainability factors” cross-refers to the same term as defined in the SFDR – ““sustainability factors” means “environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.” – see Article 2(24) of Commission Regulation (EU) 2019/2088 (the Sustainable Finance Disclosure Regulation or SFDR).

This update was authored by Richard Pugh, Aparna Sehgal and Ellen Sachs.