Warning Notice no. 1/24 of 25 July 2024

Complying with sustainability-related obligations in the provision of investment services

1. The legal framework

The rules applicable to the provision of investment services have been the object of recent significant amendments concerning the so called ‘sustainable finance’ by the EU legislator. These legislative changes are part of a broader package of EU initiatives aimed at steering markets and capital towards an inclusive and sustainable growth[1].

The main changes concern the following areas of investor protection rules under Directive (EU) 2014/65 (known as ‘MiFID II’):

• incorporating new and specific sustainability-related transparency measures in the context of client disclosure obligations, pursuant to Regulation (EU) 2019/2088, the ‘Sustainable Finance Disclosure Regulation’ or ‘SFDR’ (as amended by Regulation (EU) 2020/852, the ‘Taxonomy Regulation’)[2];
• considering clients’ ‘sustainability preferences’ as part of the assessment of suitability of investment transactions, by means of targeted amendments to Delegated Regulation (EU) 2017/565[3];
• integrating sustainability-related objectives in product governance processes, through ad hoc adjustments to Delegated Directive (EU) 2017/593 obligations applicable to manufacturers and distributors[4].

The above-mentioned requirements were implemented progressively over an extended period, with differentiated and consecutive timelines in the three areas of interest.

Moreover, the EU legal framework on sustainable finance is already evolving, with the following areas of development being particularly relevant:

1. the review of Delegated Regulation (EU) 2022/1288, supplementing the SFDR, which is expected to be adopted by the European Commission (EC), in the light of the Final Report of the Joint Committee of the three European Supervisory Authorities (‘ESAs’), published on 4 December 2023, concerning some specific proposals for amending the delegated act, also aiming at simplifying certain aspects of the requirements;
2. the launch of a comprehensive assessment process of the SFDR framework, aimed at identifying possible areas for amendment and improvement of the rules, including with regard to interactions with other frameworks (including, for example, the Taxonomy Regulation, the ‘Corporate Sustainability Reporting Directive’ (or ‘CSRD’) and MiFID II)[5];
3. the EC mandate to the three ESAs to analyse so called ‘greenwashing’ and the risks associated with it, along the entire ‘sustainable investment value chain’, including the phase of direct interaction with clients through the provision of investment services, in order to outline possible further regulatory measures, as well as to identify possible common supervisory and enforcement approaches aimed at preventing and addressing this phenomenon effectively[6];
4. the proposal for a new Regulation on the transparency and integrity of ESG rating activities[7] and the entry into force of corporate sustainability reporting obligations pursuant to the CSRD[8], due to the impact of such rules on the mapping process of financial instruments, which is relevant for the application of ESG requirements in the area of investment services.

2. Consob's supervisory action

The legal framework outlined above, which is partly still in progress, is characterised by significantly new and complex features.

In this context, Consob has launched a specific supervisory action aimed at monitoring the approaches adopted by intermediaries for implementing EU sustainability-related requirements in the provision of investment services[9].

Overall, the outcome of this activity shows an ongoing process of gradual implementation of ‘new’ sustainability-related provisions by the national industry. This is also confirmed by the number of projects observed, sometimes still ongoing, showing a progressive adoption of operational solutions which are becoming more sophisticated and more consistent with the evolving legal framework.

That said, and without prejudice to the obligation of ensuring compliance with all sustainability-related requirements applicable to the provision of investment services, this document draws the attention of intermediaries to certain key elements of the legal framework which, in light of the monitoring activity conducted and of the operational approaches observed, are believed to be worthy of careful consideration at the current stage of implementation of the rules. This Warning Notice is accompanied by a list of initial good and poor practices (see Annex), emerged from the concrete implementation of the requirements, which may be useful to support intermediaries in adopting more consistent and enhanced application approaches, in order to better comply with the legal framework.

The principles and practices referred to in this document do not cover all issues worthy of attention, which may continue emerging in the course of supervision, given the complex and evolving legal framework on ‘sustainable finance’.

3. A reminder of the key elements of the applicable legal framework

3.1 Sustainability-related disclosure under the SFDR

The Sustainable Finance Disclosure Regulation (SFDR) was designed as a set of ‘cross-sectoral’ transparency rules incorporated into various legislations, including MiFID II, with the aim of achieving a harmonised and standardised representation of sustainability-related (or ‘ESG’) information in the financial sector, to facilitate comparability and support investors in making informed choices.

The transparency obligations under the SFDR concern both the intermediary (‘entity’) and its processes, as well as the ‘products’ and services provided and their related sustainability features, by integrating different types of information (on the web, pre-contractual, periodic).

From the perspective of the entity, the SFDR applies to intermediaries providing investment advice (in their capacity as ‘Financial Advisors’ or ‘FAs’) or portfolio management (in their capacity as ‘Financial Market Participants’ or ‘FMPs’), with additional and more detailed obligations applicable to the latter, being the portfolio management service treated as a ‘financial product[10]. In the SFDR framework, there are instead no proportionality elements in relation to the nature of the end investor receiving the sustainability-related information (retail vs. professional client).

With a view to making sustainability-related information understandable and useful also for less sophisticated clients, intermediaries’ attention is drawn to the obligation of providing fair, clear and not misleading information in accordance with the standards of MiFID II and its implementing provisions. Equally relevant are the general principles referred to in Article 2 of Delegated Regulation (EU) 2022/1288 supplementing the SFDR, concerning the obligation of providing the information subject to such regulation “in a manner that is easily accessible, non-discriminatory, prominent, simple, concise, comprehensible, fair, clear and not misleading”. It is also important that such information is kept up to date, taking into account the developments of the legal framework and any related changes in internal processes.

Against this backdrop, with regard to web disclosure, for example, it is necessary to adopt adequate solutions to ensure a quick and easy identification and access, through the intermediary's website, to the overall sustainability-related disclosure at entity level (pursuant to Articles 3, 4 and 5 of the SFDR) and, where applicable, to that relating to sustainable portfolio management services.

In addition, it is particularly noteworthy avoiding confusion in explaining the two key concepts of ‘sustainability risk’ and ‘principal adverse impacts on sustainability’ (‘PAIs’). In fact, it should be remembered that these are two notions which, though distinct, are interconnected in defining the so-called ‘double materiality’ principle, which permeates the SFDR rules and the EU sustainable finance framework more generally. If investments are, on the one hand, subject to sustainability risk, defined as ‘an environmental, social or governance event or condition that, if it occurs, could cause a negative material impact on the value of the investment’ [11], on the other hand, the investments themselves, depending on their specific type, can have negative impacts on the environment and society[12].

Both the above-mentioned variables must be considered in the selection process of investment products on behalf of clients by intermediaries. These processes must be reflected both in the disclosure pursuant to Article 3 SFDR on the integration of sustainability risk into investment advice or portfolio management, and in the Statement on the consideration of PAIs pursuant to Article 4 SFDR (where applicable). But since the underlying rationale may be different, as the purposes are distinct[13], special care must be taken by intermediaries in illustrating the respective policies with the necessary clarity.

Another concept often mentioned in the context of website disclosures pursuant to Article 3 of the SFDR, or also in the pre-contractual disclosure pursuant to Article 6 of the SFDR, is that of clients’ ‘sustainability preferences’, which intermediaries must take into account in the investment advice or portfolio management process, for the purposes of assessing the suitability of investments[14]. In such cases, it should be noted that, for the purposes of clarity and correctness, it is necessary to provide a clear and simple explanation of the possible connection, in the intermediary's processes, between the selection of ESG products on the basis of sustainability risk and the ability to meet the sustainability preferences of clients[15].

With regard to those disclosure obligations for which the SFDR framework has defined specific templates and detailed related instructions pursuant to level 2 measures, such as, for example, the Statement on principal adverse impacts by FMPs and the pre-contractual and periodic disclosures of portfolio management service classified under Articles 8 and 9 SFDR, it is reminded the importance of complying with such templates and related instructions, as well as with the timing of publication. This is because by abiding by the rules when providing these formats further contributes to improving the quality and effectiveness of the disclosure itself[16].

Finally, it should be recalled that the obligations specifically applicable to intermediaries in their capacity as FMPs when providing portfolio management services classified under Articles 8 and 9 of the SFDR include the publication on the web, in a specific section entitled ‘Sustainability-related disclosures, pursuant to Article 10 of the SFDR, of information on the characteristics of such portfolio management services and the related periodic information pursuant to Article 11 of the SFDR.

3.2 Assessing clients' sustainability preferences as part of the suitability test

The EU legislator has introduced an elaborate and complex definition of clients’ ‘sustainability preferences’[17], which is integrated into his/her investment objectives, requiring intermediaries who provide investment advice or portfolio management services to take them into account as part of the suitability assessments.

Right from the stage when sustainability preferences are acquired, to allow clients to their preferences with awareness, intermediaries must illustrate the meaning of this new notion, with all its various components, and the key underlying concepts, using a clear language and avoiding the use of excessively technical terms[18].

Intermediaries are also required to ensure an adequate level of granularity in the collection of information on clients' sustainability preferences, by taking account of the different variables that characterise the aforementioned legal concept, in addition to any additional elements deemed necessary, based on the algorithm adopted for the assessment of suitability (such as, for example, the percentage of sustainable investments at the portfolio level desired by the client)[19].

Therefore, an extremely simplified approach for the acquisition of sustainability preferences, which simply investigates, for example, the interest in sustainable investments in general, and/or in the individual sustainability pillars (E, S, G) and/or the percentage of the portfolio to be allocated to ESG investments, would not allow clients to communicate their preferences to a sufficiently granular level.

With regard to the products mapping step of the suitability test, it is also important for intermediaries to analyse products’ sustainability characteristics with an adequate level of detail, so as to enable an effective comparison with clients’ preferences[20].

In this regard, it should be noted that the increasing availability of data and other information useful for qualifying products in terms of sustainability now makes it possible to implement more sophisticated and granular mapping processes, thus going beyond the approaches simply aimed at distinguishing between ‘ESG’ and ‘non-ESG’ products (according to a so-called ‘on/off’ logic), without graduating the classification also in terms of the level of sustainability ‘ambition’[21].

The ‘models adopted for ‘matching’ the client's sustainability preferences with the ESG features of the products observed in practice are structured in different ways. In particular, there are cases of ‘pure’ portfolio approach, ‘mixed’ approaches (i.e. with a component of the test based on the portfolio, accompanied by a check at product level) or models based only on the ‘assessment at the level of the single product’.

In this context, although intermediaries are free to independently choose and adopt the operating models considered most appropriate to them, also taking into account the characteristics of their clients, the content of the services provided and the range of products offered, it is important to highlight that excessively simplified operational solutions may not be able to ensure that the investments recommended (or made on behalf of the client) are actually suitable in terms sustainability preferences, which is the goal that the legal framework aims to achieve with a view to also mitigating the risks of greenwashing and mis-selling[22].

Moreover, it should be remembered that, within the mechanisms adopted for the assessment of sustainability preferences, intermediaries are required to ensure that the client is always given the possibility of ‘adapting’ his/her sustainability preferences if no product meets them, so long as a record of the decision taken is kept. But this decision should not determine a change in the client's sustainability preferences initially acquired through the questionnaire[23]. Indeed, this measure has been specifically introduced, acknowledging that products with different sustainability ambitions are available, to mitigate the risk of greenwashing by allowing that a negative result of suitability assessment can be ‘overcome’ with respect to sustainability preferences, provided that the client is duly informed (and provided that the product is suitable with respect to the other parameters of suitability assessment)[24].

In this context, the monitoring of adaptation cases is particularly important as it represents a means to verify that the procedures for assessing sustainability preferences are correctly structured and implemented in their various phases (e.g. recording an extremely small number of cases could be indicative of approaches not particularly stringent in terms of mapping or control thresholds, while conversely, a very high number of adaptations could be a sign of opportunistic conducts by the intermediary or a range of ESG products on offer that is not consistent with the preferences of the clients).

When providing the service of investment advice to retail clients, it is also necessary to provide, through the ‘suitability report’ (or ‘statement on suitability’), appropriate details on the positive result of the suitability test, including in terms of sustainability preferences, as well as on the client's possible decision to adapt their preferences.

3. Consideration of sustainability-related objectives in product governance processes

In pursuing the EU sustainable finance strategy, product governance requirements have been integrated to ensure that sustainability factors[25] and sustainability-related objectives of target clients are incorporated into intermediaries’ processes adopted to define the range of products to be manufactured and distributed, as this "encourages investors’ demand for sustainable investments"[26].

Intermediaries, in their capacity as manufacturers and distributors, are therefore required, when defining the target market for the products they intend to manufacture and distribute and the related distribution strategy, to specify among the objectives of clients, in addition to those of a typically financial nature, also ‘any sustainability-related objectives’.

As clarified by ESMA in the latest update of the above-mentioned Guidelines on product governance requirements, sustainability-related objectives should be set out, with an appropriate level of granularity, within the target market category referring broadly to the ‘client’s objectives and needs’[27]. For example, in addition to the distinction between products that consider sustainability and those that do not, the elements that characterise the definition of ‘sustainability preferences’ referred to in letters (a), (b) and (c) of Article 2(7) of Delegated Regulation (EU) 2017/565 could also be taken into account, in line with the ESMA guidance[28].

In line with the general goal of promoting the dissemination of ‘sustainable products’, i.e. those that consider sustainability factors, it should also be recalled that intermediaries are not required to identify the ‘negative’ target market [29], solely with respect to the driver of sustainability-related objectives, without prejudice to the application of this obligation on the negative target market in relation to the other categories[30].

In this regard, intermediaries’ attention is drawn to the fact that, for products that do not consider sustainability factors (‘so called ‘Non- ESG’ products), as clarified by the EC, it is instead necessary to assess on a case-by-case basis, taking into account the specific features of the products themselves, whether a negative target market in terms of clients’ sustainability objectives should be identified[31].

As regards distributors, in particular, it should be noted that since sustainability-related objectives are among the parameters that contribute to the ‘ex-ante’ identification of the range of investment products and services on offer, in line with the needs, characteristics and objectives of target clients, they should also influence the processes related to the definition of commercial and marketing policies, budgets and personnel remuneration systems[32].

Finally, it is important to recall that manufacturers and distributors are also required to take into account any sustainability-related objectives for the purposes of the periodic review of the products manufactured and distributed. More specifically, intermediaries should identify the sustainability features of products that more likely may be subject to changes and monitor them, in order to verify the need for a possible target market modification in terms of sustainability-related objectives or (in the case of distributors) for changes in the range of products offered.

4. Conclusions

In light also of this Warning Notice, Consob will continue its supervisory action focused on the approaches adopted by intermediaries for implementing sustainability-related requirements in the provision of investment services.

This activity will also be carried out in coordination with ESMA, in particular as part of the Common Supervisory Action already announced for 2024, which is focused on MiFID II sustainability-related requirements regarding suitability assessments and product governance[33].

In addition, Consob will continue interacting at the appropriate levels to ensure a uniform application of the SF legal framework at EU level, as well as contributing to the ongoing debate on the review and simplification of the requirements outlined above.

THE CHAIRMAN
Paolo Savona

ANNEX

Initial examples of ‘good’ and ‘poor’ practices[34]

SUSTAINABILITY-RELATED DISCLOSURE (SFDR)[35]

I) Practices relevant both for ‘FAs’ and ‘FMPs’

II) Practices relevant for intermediaries in their capacity as ‘FAs’

III) Practices relevant for intermediaries in their capacity as ‘FMPs’

ASSESMENT OF SUSTAINABILITY PREFERENCES AS PART OF THE SUITABILITY TEST