Behavioural finance experts, Oxford Risk are warning that MiFID sustainable investment regulations are risking the “worst of outcomes” from the best of intentions by leaving too much up to interpretation.
The regulations, which take effect from August 2nd, mean retail investment clients must now be consulted on their sustainability preferences.
Wealth managers must consider how much of their portfolio investors want in sustainable investments, how much they want in environmentally focused investments, and which adverse impacts, such as arms and tobacco, should be reported on.
But Oxford Risk warns that these requirements run the risk of investors ending up with “token-gesture allocations to a fund that changed its name to include ‘sustainable’ a couple of weeks before”, meeting the letter of the law but not the spirit.
It advises wealth managers to ensure they’re using a behaviourally robust assessment of investors’ sustainability preferences and to build them into a comprehensive suitability methodology. They need to recognise and account for the moving parts of financial preferences and to identify and integrate trustworthy ESG assessment criteria.
Greg B Davies, PhD, Head of Behavioural Finance, Oxford Risk said: “All over Europe, we’ve spoken to the people that must interpret and implement this guidance. The only point on which they can agree is that they can’t agree on how to interpret it, but they must implement it by 2nd August regardless.
“Some element of being open to interpretation is necessary. But this is no excuse for encouraging confusion. Prioritising matching ticks to boxes over matching investors to suitable solutions will turn the best of intentions into the worst of outcomes.”
Oxford Risk has launched a guide for wealth managers and financial planners to help support them in meeting global financial regulation including European MiFID compliance rules by 2nd August this year. The guide is available at ESG The Compelling & The Compliant [Guide] (oxfordrisk.com)
Oxford Risk’s ESG Suitability tools provide a solid scientific grounding to the questions of how much sustainable investing is suitable and of this, how much should be weighted towards specifically environmental causes. Launched in 2019, they continue to evolve based on Oxford Risk’s market-leading behavioural research.
The ESG suitability framework for wealth managers focuses on precise psychometric measurement of how much ESG each investor should be encouraged to have in their portfolio, and how from far down the impact spectrum components should be selected. It also examines instrument selection to drive suitable asset allocation and looks at ongoing investor management and the use of tailored behavioural messages to improve investing decisions.
Oxford Risk’s behavioural tools assess financial personality and preferences as well as changes in investors’ financial situations to build a comprehensive profile. The financial personality tests can measure up to 18 distinct dimensions, of which six reflect preferences for ESG investing.
It believes the best investment solution for each investor needs to be anchored on stable and accurate measures of risk tolerance. Behavioural profiling then provides an opportunity for investors to learn about their own attitudes, emotions, and biases, helping them prepare for the anxiety that is likely to arise. This should be used to help investors control their emotions, not define the suitable risk of the portfolio itself.