New EU ESG Rules Cause Confusion

A new set of European Union (EU) rules coming into force Tuesday will put fresh pressure on asset managers as they seek to steer everyday retail investors around the complexities of sustainable investing.

The changes are the result of an amendment to the revised Markets in Financial Instruments Directive, or MiFID. It requires investment managers and financial advisers to understand and act on the “sustainability preferences” of retail clients. These investors, in turn, can hold asset managers to account if their environmental, social, and corporate governance (ESG)–focused funds don’t meet expectations—by not being as green as they might initially appear, for example.

In practice, many are still concerned about the lack of granular data on ESG issues; the challenge of defining what makes for a sustainable investment; and uncertainty about how the new rules will be enforced by individual countries. Europe’s financial services industry, which lobbied for the amendment to be delayed, warned it will cause “huge confusion” and “great legal uncertainty.”

“It’s going to be difficult to explain to clients who aren’t savvy on EU regulation what this all means in practical terms,” said Ben Maconick, a managing associate at the law firm Linklaters.

Under the new rules, sustainability is defined by piggybacking other parts of EU legislation such as the green taxonomy and the Sustainable Finance Disclosure Regulation. Investment firms are already struggling to apply EU metrics and assess the sustainability of certain investments.

Financial firms are “in a really hard situation because they have the obligation to ask these questions and only suggest investments that are aligned with the client requirements,” said Matthias Breier, ESG product manager at FE fundinfo. “But they just do not have the required data on sustainability at the moment.”

Further confusion stems from how national regulators in the bloc will enforce the rules. The International Capital Markets Association, a financial trade group, is among those calling on the European authorities to not prioritize supervisory action for at least a year.

France’s market regulator, AMF, has said the new requirements will not apply to French investment advisers until 2023. The Dutch watchdog, AFM, told Bloomberg there may be “a lack of clarity” regarding appropriate products that match the ESG preferences of clients.

“The European Securities and Markets Authority [ESMA] has not issued any guidance to national competent authorities concerning the prioritisation of enforcement of the MiFID II Delegated Regulation, which applies from today,” an ESMA spokesperson told Bloomberg Tuesday. “ESMA is currently engaged in the development of guidelines in order to facilitate the understanding of the new requirements across the EU.”

A key hurdle is the lack of comparable data. Funds with similar holdings have reported wildly different minimum allocations to sustainable investments, mainly because regulator guidance can be interpreted in different ways, according to a recent analysis by Morningstar Inc.

What’s more, around a third of the market has yet to submit any data on sustainability, according to FE fundinfo. Funds are filling out industry templates with almost 600 different fields.

“An adviser’s work will be hamstrung by the mere fact that many funds haven’t reported the required information yet or have reported zero exposure to sustainable investments,” said Hortense Bioy, global director of sustainable research at Morningstar.

The new MiFID requirement comes at a time when the ESG investing movement is facing criticism from multiple sides. Republicans have characterized it as a tool of the “woke” left. Meanwhile, some whistleblowers have suggested that ESG—as practiced by the mainstream—is more marketing than action.

See also:

• The SEC War on Greenwashing Has Begun
• Treasurers’ Role in ESG and DEI
• The Virtue Bubble Is About to Burst. Good Riddance.

—With assistance from Tasneem Hanfi Brögger, Alexandre Rajbhandari & Cagan Koc.

Copyright 2022 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.