Investment firms and unit linked insurance providers will now be required to ask clients about their sustainability preferences and reflect them in the client’s portfolio. As European companies move to comply, expect to see major launches of various sustainable solutions covering risk profiling and portfolio construction, which will definitely have a spillover effect into Asia’s investment landscape. About the MiFID IIMiFID II is a legislative framework instituted by the European Union (EU)’s securities market regulator, the European Securities and Markets Authorities (ESMA). It regulates financial markets within the EU blocs and includes protections for investors. All aspects of financial investment, trading, financial institutions and financial professionals must abide by MiFID regulations.On the 27th of January 2022, ESMA published a consultation paper outlining in detail the proposed changes to certain aspects of the MiFID II suitability requirements. In addition to mandating that investment firms obtain basic client information such as the client’s knowledge and experience in the investment field, they should also determine the client’s sustainability preferences.Under these proposed guidelines, firms must:Collect information from clients on their sustainability preferences, such as their preferences regarding different sustainable investment products and the extent to which they want to invest in these products.Using this and other relevant information, the firm should identify the products that fulfill the client’s sustainability preferences.Provide staff with appropriate training on sustainability topics and keep updated records of the client’s sustainability preferences.ChallengesHowever, these proposed guidelines pose challenges for many investment firms. The ESMA announced that they would only collect feedback until the 27th of April, 2022, which has since passed. With the amended Delegated Regulation coming into effect on the 2nd of August 2022, investment firms have a very short time period for them to modify and adapt their projects to be compliant.Some of the data needed to be compliant is also not yet available. For example, the mandate for investment products to have detailed reporting requirements only comes into effect on the 1st of January 2023. Firms may lack the necessary reporting and information to fully disclose and adjust their sustainable ratings.Firms may also be unable to meet their client’s sustainable needs. Staff may not have necessary knowledge or experience when dealing with sustainability preferences and may lack the confidence to explain them to clients. Having to identify and adhere to specific percentages of sustainability preferences of clients may also result in clashes between the client’s other preferences or repetitive assessments that may be time-consuming for both the client and the firm.Furthermore, there is concern that this will lead to ‘green-bleaching’, where, to avoid the complexity that arises with sustainability disclosures and reporting, firms invest in sustainable funds but do not declare so, or stop investing in them entirely.ExceptionsThe ESMA also laid out some provisions for special cases that an investment firm may potential face:If a firm wishes to recommend a product that does not meet the client’s sustainability preferences, it can only do so once the client has modified their sustainability preferences to match the product.If a firm cannot meet a client’s sustainability preferences, it should discuss this with the client and ask the client to modify their preferences. This decision should be documented. If the client does not wish to modify their preferences and the firm does not have any products that match available, this should also be included in the suitability report.If the client expresses no sustainability preferences, the firm can consider this client as ‘sustainability-neutral’ and recommend products that contain or do not contain sustainable themes.Conclusion As the date for providing feedback on the proposed guidelines has passed, only time will tell how the ESMA ultimately decides to incorporate sustainability into MiFID II. However, firms should start preparing now on the basis of the proposed guidelines, so that they can be ready when the Delegated Regulation goes into effect. Firms based in Asia should also be prepared for sustainable investing to become more mainstream and popular as these new sustainable offerings are launched one by one.