MiFID Suitability Guidelines – ESMA consults

On 27 January 2022, ESMA published a consultation paperwith a view to updating its November 2018 Guidelines on certain aspects of the MiFID II suitability requirements.

ESMA's review of the guidelines takes into account

• the amendments made in August 2021 to the MiFID II Delegated Regulation to integrate sustainability factors, risk and preferences into investment firms' organisational requirements and operating conditions. These changes come into effect on 2 August 2022. For more information, please see our summary here

• the results of ESMA's 2020 Common Supervisory Action (CSA) on progress made by intermediaries in applying the MiFID II suitability rules across the EU and

• the amendments introduced to Article 25(2) of MiFID II by the Capital Markets Recovery Package.

Who should read this and why?

EU MiFID firms who provide investment advice or portfolio management will need to review and amend their suitability assessment procedures and policies in good time prior to 2 August to take account of the requirement to consider their clients' sustainability preferences.  Unlike the financial elements of a suitability assessment, the non-financial sustainability preferences will be substantially based on self-assessment and firms acting as intermediaries will need a substantial uplift to devise systems and processes that will allow for matching of products with preferences.  Such firms will no doubt welcome further regulatory guidance, particularly where it provides practical suggestions for implementation.

Similarly, product providers (who may not be directly subject to the MiFID rules) are keen to identify how their products may be sold and what they will need to do in order to ensure their products are best positioned to take advantage of the changes to suitability assessments. 

As the final report is not intended to be published until at best a month before the changes to the suitability assessments are in force, many firms will be analysing this consultation paper closely to ensure they understand ESMA's direction of travel.

What's the next step?

The ESMA consultation closes on 27 April 2022. ESMA expects to then publish a final report followed by the final guidelines in Q3 2022.

ESMA also intends to consult separately on the product governance changes to MiFID II made under the EU's ESG framework in August 2021 - see our summary here. These changes come into effect on 22 November 2022.

Why has ESMA published the consultation paper?

The consultation paper refers to the assessment of suitability as being "one of the most important protections for investors under MiFID II", applying as it does to the provision of all types of investment advice and portfolio management.

In July 2012, ESMA published its first set of guidelines on MiFID suitability requirements. These were revised in November 2018, following the adoption of MiFID II.

In August 2021, the MiFID II Delegated Regulation was amended to require firms to:

• collect information from clients on their preferences in relation to the different types of sustainable investment products and the extent to which they want to invest in these products

• identify

  • a range of products for the client which are suitable, based on the client's knowledge and experience, financial situation and other investment objectives and then
  • products that fulfil those sustainability preferences and

• give staff appropriate training on sustainability topics and keep appropriate records of the client's sustainability preferences, along with any updates of these.

Although these amendments have been the primary trigger for the consultation, ESMA is also taking the opportunity to review and update its November 2018 guidelines to consider other matters including (a) identification, through the 2020 CSA, of both good and poor practices in how intermediary firms are applying the suitability rules across the EU and (b) the recent finalisation of ESMA's Guidelines on appropriateness and execution-only requirements so the two sets of guidelines can be better aligned.

What amendments has ESMA proposed?

The consultation paper makes a number of proposals, set out below. Where a guideline is not referred to, ESMA has concluded that the existing measure does not need to be amended.

(a) Changes resulting from the amendment to the MiFID II Delegated Regulation

Guideline 1 - Information to clients about the purpose of the suitability assessment and its scope

ESMA has proposed the insertion of a new paragraph to clarify that, as part of the suitability assessment, firms should help clients understand the concept of "sustainability preferences", the different types of products included under the definition of this term and the choices that need to be made in this context.

Guideline 2 - arrangements necessary to understand clients

ESMA's proposal adds a new requirement for firms to collect information from a client on its sustainability preferences.

Outlining the approach a firm should follow to establish these preferences and the client's level of sustainability-related expectation, ESMA notes that the level of information to be collected should

• include all aspects mentioned in the definition of "sustainability preferences"

• be granular enough for the firm to be able to match the client's sustainability preferences with the sustainability-related features of financial instruments and also to allow for a combination of the different aspects included under the definition of sustainability preferences.

The same level of granularity of information should be collected on the client's sustainability preferences when providing portfolio management or investment advice with a portfolio approach.

Note that (unlike when collecting information on the 'traditional' parameters of suitability assessment), ESMA suggests that gathering information about a client's sustainability preferences may be substantially based on self-assessment.

Guideline 5 - updating client information

A new paragraph added to the existing guideline clarifies that, in relation to the collection of the sustainability preferences of a client, this information could be updated either as part of the next regular update of the client's information or during the first meeting with the client following 2 August 2022, when the amendments to the MiFID II Delegated Regulation start to apply. This reflects previous Commission guidance and will be helpful for those firms preparing for 2 August 2022 in respect of their existing clients.

Guideline 7 - arrangements necessary to understand investment products

ESMA is proposing to amend the supporting guideline under Guideline 7 to ensure that the policies and procedures implemented by firms to understand the characteristics, nature and features of investment products take into consideration sustainability factors of the investment products.

Guideline 8 - arrangements necessary to ensure the suitability of an investment

Guideline 8 is amended to outline the approach a firm should use in assessing the client's sustainability preferences as part of the suitability assessment. The changes

• clarify that the suitability of the product must be assessed first in accordance with the criteria of knowledge and experience, financial situation and other investment objectives and the client's sustainability preferences then assessed as a second step

• propose that, in respect of a firm's ability to recommend a product that does not meet the initial sustainability preferences of the client, a firm may still make such a recommendation but only 'once the client has adapted [its sustainability] preferences'. Both the firm's explanation and the client's decision should be documented in the suitability report. This restriction would appear to go beyond the amendments to the Delegated Regulation which could be interpreted as permitting a recommendation of a product not meeting a client's sustainability preferences, provided it was not recommended as meeting such preferences.

• clarify that the adaptation of the client's "sustainability preferences" where financial products do not meet these preferences should refer only to the suitability assessment in question or to the particular transaction (rather than to the client's profile in general)

• recognise that, for the time being, the availability of financial instruments with sustainability features may be limited. Even so, ESMA's view is that where, at the time when the information is collected from the client, a firm does not have any financial instruments in its product range that would meet the client's sustainability preferences, the firm should nevertheless collect all information concerning sustainability preferences, clearly indicating to the client the absence of products that would meet those preferences and giving the client the opportunity of adapting its sustainability preferences. Again, this should be documented in the suitability report

• address the situation where a client does not express sustainability preferences.

Guideline 10 - costs and benefits of switching investments

The text of Guideline 10 would be aligned with Article 25(2) of MiFID II as amended by the Capital Markets Recovery Package.

Guideline 11 - qualifications of firm staff

ESMA's amendment clarifies that firms should give appropriate training to ensure that staff who give investment advice or information about financial instruments

• have the necessary knowledge and competence with regard to the criteria of the sustainability preferences and

• are able to explain to clients the different aspects in non-technical terms.

Guideline 12 - record-keeping

Although the content of the 2018 guidelines on record keeping has not changed, ESMA has proposed clarification that firms should keep records of the sustainability preferences of the client (if any) and any updates to these preferences.

(b) Other changes to the guidelines

Alignment with the Guidelines on appropriateness and execution only

When it finalises its suitability guidelines, ESMA will look to align these with its Guidelines on appropriateness and execution only (published as a Final Report on 3 January 2022) where there are common provisions under MiFID for both the assessment of suitability and appropriateness.

Incorporating good and bad practices from the 2020 CSA

In 2020, ESMA and the EU NCAs conducted a CSA on the application of MiFID II suitability rules across the EU.

This assessed what progress had been made by intermediaries in applying key requirements such as whether and how firms take costs and complexity of an investment product into account when recommending them to a client.

This revealed some shortcomings when improvement could be made with regard to some of the new requirements introduced by MiFID II - notably the requirement to consider the cost and complexity of equivalent products, the costs and benefits of switching investments and suitability reports.

ESMA has included a list of good and bad practices which came out of the CSA as an annex to the Guidelines to "provide further guidance to firms and to increase convergence on these important MiFID II requirements".