When wealth managers check investments for suitability, environmental, social and governance issues will be part of the equation from 2 August under the MiFID II rules of the EU that originally took force in 2018.

New European rules will require environmental, social and governance (ESG) preferences to be embedded into the way wealth managers judge what investments suit clients best. Consequently, technology must adapt, Avaloq, the financial industry technology firm says. 

The changes add to the MiFID II directive that took effect in 2018. The deadline for financial firms to start including ESG preferences is 2 August. 

The move is part of European Union policymakers' efforts to drive the ESG agenda and tackle problems such as “greenwashing” – the ploy of making investments appear to be “greener” than they really are.

“Sustainability preferences will now have to comprise a routine part of the investor profile,” Martin Greweldinger, co-CEO of Avaloq, said in a note. 

“Under this latest amendment to MiFID II, wealth managers will need to proactively assess their clients’ sustainability preferences in the same way that risk tolerance and investment knowledge are measured currently,” he said. “The upcoming amendment to MiFID II not only requires a cultural shift within the industry, but wealth managers will also need to apply an ESG classification system – based on regulation as well as industry standards such as EET (European ESG Template) – to create a list of environmentally sustainable products and define how these products align with investor preferences.”

“As we approach the August deadline, wealth managers should conduct a gap analysis to check that their investment platform can guarantee compliance with changing regulations for EU-based clients, with data-backed ESG investment products that cover both discretionary and advisory mandates,” Greweldinger said. “This will allow them to identify any shortcomings in the investment journey and, where necessary, evaluate the need for a specific ESG solution for their business.”

Such requirements show how ESG ideas, whatever the motivation, are adding to the requirements – and therefore costs – that wealth managers must wrestle with when dealing with clients. Such cost pressure also explains industry consolidation as firms target economies of scale to handle compliance burdens.

Greweldinger added: “The easiest way for financial institutions to meet these new requirements is to add an ESG layer on top of their existing framework for determining investor suitability – with an expanded investor questionnaire, the addition of standard ESG ratings and new exclusion criteria.”

Greweldinger is optimistic that the changes could spur firms into taking ESG seriously. 

“The changing regulatory landscape will give ESG investing a much-needed overhaul and align it with the expectations of investors. But it is also an opportunity for financial institutions to position themselves as ESG leaders instead of simply playing compliance catch-up,” he said.