A lot has been said of the regulatory tsunami facing the asset and wealth management sectors in recent years. MiFID II will have added ESG questions that have to be asked but it’s the whole new Sustainable Finance Disclosure Regulation (SFDR) which really piles on the pressure. 

Speaking to Manmeet Rana (pictured), a partner at Aurexia Consulting and an expert on all things regulatory, she took Fundeye through the roadmap that led to SFDR. She said while the updated Markets in Financial Markets Directive (MiFID II) has always applied to wealth managers (and before that similar initiatives by the legacy FSA) there are some clear differences.

For instance, if an asset manager wants to escape from the clutches of MiFID II, it could in many cases set up as an AIFM or UCITs firm and not offer discretionary portfolio managements. Wealth managers don’t have this luxury, as Ms Rana said that even a mid-size UK manager will really be captured by MiFID (in a hypothetical situation) you’re a pension specialist providing investment advice on non-MiFID products.

As most wealth managers offer investment advice, execution only and portfolio management, they’re bound to get caught by one of the EU’s many regulations. Going back to the evolution of ESG products, Ms Rana said the main impetus was to catch millennial investors or the younger generation with products that might appeal to them.

Unfortunately, asset managers have continually come up with their own ESG products based on what they think ESG means, which as Sparrows Capital consultant Professor Elroy Dimson recently pointed out, is highly subjective.

In steps the EU, which in 2018 started down a path that would later be dubbed Taxonomy, and tries to build a standardised version of ESG. The first part of the action plan was to divert capital into sustainable investments and the second part was anticipating and managing sustainability risks.

“Different firms have different definitions of ESG which doesn’t encourage investment,” says Ms Rana.

For this reason, concerning improving investor disclosures so a client can see how a product meets ESG criteria, is how SFDR was born. This new regulation, along with tweaks to existing regulations such as MiFID II are all aimed at pushing greater capital towards sustainable investing.

Proud sinners

But what if a client simply doesn’t care about sustainable investing, wants to put their money into the most climate unfriendly stocks available? Here Ms Rana said that SFDR may still come into play. For instance, if a client wants to hold to a US wheat company (in addition to their nuclear arms, tobacco and porno stocks) that has hundreds of acres in the American Mid-West, if in 20 years this will be reduced to desert due to climate change, then wealth managers are being forced to integrate sustainability risks into their investment decision and advice processes.

The EU Taxonomy only deals with environmental issues at the moment but is looking for greater harmonisation of products. The proliferation of ESG products is something that wealth managers have to deal with and asset managers are constantly coming up with ways to distinguish their ESG fund from another by, in some instances, showing how much of their investee companies revenues go towards furthering a UN Sustainable Goal for instance.

“I think wealth managers will be relying heavily on asset managers to provide product level disclosures, however wealth managers will need to do their own data aggregation,” said Ms Rana and there’s the rub. Asset managers (or the ‘manufacturers’ as ESMA dubs them) want to sell as many products as possible. 

Given MiFID II’s target market regime - that sets out the importance of both asset managers and distributers communicating to ensure the suitability of a product for the end investors - the onus is on both to make sure this happens. Although it doesn’t look like the UK is heading down the ‘nanny state’ role anytime soon, its imminent departure from the EU at the end of year might be seen as a plus for those happy to see the world a victim of its own indulgences.