One of the last and least noticed parts of the EU’s Sustainable Finance Action Plan is about to come into force in August.
This is the requirement for all investment advisers to ask their clients what their sustainability preferences are, and then explain to what extent their products match those requirements.
It sounds basic, and unequivocally a good thing. But it is proving remarkably tricky to implement.
How do you discover and explore all the complex and varied thoughts investors may have about sustainability and how much they care about it? Then how can you turn that information into organised data that is usable by the investment industry?
The new sustainability preferences rules have been hitched to the revision of Mifid 2.
Ironically — and annoyingly for those who have to implement it — they will begin to apply before much older blocks of sustainable finance regulation, on which they depend, such as certain disclosures on the Taxonomy and Sustainable Finance Disclosure Regulation.
The industry fears the sustainability preference rules could prove at best one more tedious compliance labyrinth, at worst a recipe for accusations of greenwashing and mis-selling lawsuits.
Yet if finance is to genuinely advance the cause of a greener and fairer economy, this step is perhaps the most powerful in all sustainable finance regulation.
Fundamentally, it means putting the end investor back in charge of his or her money, and allowing the investor’s ethics to govern what that money does in the world. It strikes at the heart of the denial or outsourcing of intelligent thought and responsibility that has allowed organised capital markets to push the world to the brink of destruction in pursuit of pure profit.
The greatest danger with this regulation is not complexity and lawsuits, but that it is neutered and becomes a bland box-ticking exercise that is convenient for everyone, but conveys no real meaning or challenge.
The difficulties of implementation are real, and must be addressed. It may be too late for the EU, certainly in this regulatory round, as it has taken its all too common route of over-complexity.
But the UK, US and other countries have yet to decide how to govern this issue.
They should follow this principle: make the investor choices very clear and simple, yet ambitious.
One suggestion for the questionnaire would be to give investors four levels of sustainability: that they want to concentrate on financial reward alone; would prefer to invest sustainably, as long as it does not impair financial return; that they would be willing to sacrifice some potential return to invest sustainably; and that they would be willing to take on some more risk for sustainable ends. Ask them what percentages of their money they want to put in each bucket.
Then put the onus on fund managers and advisers to explain how products match these objectives. This explanation should be explicitly accepted by the client, in the way customers now have to sign that they have understood a financial product.
This system should eliminate box-ticking, create clarity, preserve full flexibility within the buckets in the investment choices offered to clients, defend the ESG industry from its critics and minimise the risk of litigation.
Even tiny percentages allocated to the more daring categories could multiply the money available to specialist impact investors overnight. Once investors can feel their money is doing good, their enthusiasm is only likely to grow.