As a result of the transposition of Delegated Directive (EU) 2021/1269 by the Order of 25 July 2022, investment firms (and credit institutions providing investment services) will be required to take sustainability factors and sustainability-related objectives in product governance requirements into account, as of 22 November 2022.
Product governance obligations have been one of the most important evolutions introduced by MiFID 2 in terms of investor protection. Thus, since 2018, investment service providers have had to pay greater attention to the entire product distribution process, from their design to their distribution to the end client. In addition, the exchange of information between producers and distributors has also been strengthened.
This new product governance obligation stems from the European Commission’s Action Plan on Financing Sustainable Growth, dated March 2018. This Action Plan aims, in particular, at redirecting capital flows towards sustainable investments with a view to achieving sustainable and inclusive growth. Indeed, the European Commission considers it necessary for relevant stakeholders to take into account sustainability factors and sustainability objectives, as part of their product governance requirements. This objective was included in the European Green Deal presented in December 2019 by the European Commission. The mobilization of the financial sector requires new rules for investors to consider the sustainability of investments to avoid stranded assets and promote finance for a sustainable economy.
In concrete terms, and as of 22 November 2022, investment firms will be required, for each financial instrument they produce and distribute to:
- take into account sustainability factors in (i) the product approval procedure for each financial instrument, and (ii) the other product governance and supervisory arrangements governing each financial instrument intended for distribution to clients seeking financial instruments with a sustainable profile,
- conduct a review of the target markets for financial instruments to clarify to which client groups the financial instruments are intended to be distributed, based on these clients’ specific objectives and possibly taking into account sustainability objectives, (so that financial instruments with sustainability factors remain easily identifiable and accessible; investment firms should not be required to identify negative target markets),
- conduct a review of information for distributors and end investors so that the sustainability factors of the financial instrument can be presented in a transparent way.
This new product governance obligation is part of a broader context, also stemming from the European Commission’s Action Plan and Green Deal’s aim to integrate sustainability factors, risks and preferences into certain organizational requirements and operating conditions applicable to investment firms (obligations applicable since 2 August 2022).
Such obligations have had an impact on, inter alia, the following elements of investment firms’ internal arrangements:
- the adequacy assessment framework, with the integration of clients’ sustainability preferences as part of the suitability requirements of the financial instrument or service (when providing the investment advisory or portfolio management service on behalf of third parties),
- the mechanism for the prevention and management of conflicts of interest, with the integration of clients’ sustainability preferences in the context of the identification of the types of conflicts of interest that may arise and harm clients in the case of, inter alia, the provision of investment services (including when periodically updating the adequacy assessment),
- the risk management framework, with the consideration of sustainability risks as part of the updates and operational maintenance of risk management policies and procedures to identify risks related to the company’s activities, processes and systems,
- the general organizational requirements of the company with consideration of sustainability risks (e.g. where the company establishes, implements and maintains operational decision-making procedures and an organizational structure specifying in a clear and documented form the reporting lines and the distribution of functions and responsibilities).
These series of bonds, with close entry into force dates (August and November 2022), are expected to contribute to enhancing the transparency of financial instruments markets in the European Union, for the benefit of clients of investment services providers. The European Commission’s challenge is to boost demand for financial instruments that direct investments towards everything sustainable.
