For UK financial advisers only, not approved for use by retail customers

Retro is ‘in’ but be careful with the compliance risk

We’ve seen a plethora of new ESG/Sustainable funds launched this year. However, ESG Accord’s Lee Coates discusses why he believes that advisers should be concerned about the fashion for retrofitting an ESG/Sustainable process into existing funds.

Why should advisers be bothered with retrofitting? Well, it has serious compliance implications, impacts on the advice process, and could force early annual reviews for existing clients. Quite important then – let me explain.

This retrofitting impacts on PROD (the Product Intervention and Product Governance Sourcebook) and Target Market requirements for firms. PROD is part of the FCA’s objectives to deliver better outcomes for investors. By using the term ‘target market’ the Regulator aims for the Manufacturers (Asset Managers) and Distributors (Advice Firms) to match target market descriptors with their client needs.

Yes, yes, you know all of that, but here’s the issue. By retrofitting ESG and Sustainable processes, the fund managers have significantly changed the Target Market designation for the funds.

Tech talk

Apologies, it’s going to get a little technical for a while, but it’ll be worth it – below are a few requirements taken from PROD and our responses in respect of ESG and Sustainable Finance:

  • Advisers must fully understand the funds they are distributing and ensure they meet client needs at all times; a fund recommendation made last week, last month or last year, which has had ESG retrofitted, needs to be reviewed for every client, to ensure ongoing suitability
  • Distributors must identify fund target markets and a distribution strategy, even if fund providers haven’t defined their Target Market; has ESG been retrofitted to funds previously sold, does the fund still match client needs and, critically, have you asked the client what they think? Can you identify every fund that has been retrofitted with an ESG/Sustainable process?
  • Assessment of funds must be to sufficient granular detail; you need to know how this new ESG/Sustainable process affects the funds you’ve recommended and be able to compare different approaches. Remember, there’s no single approach to ESG – everyone does it differently (that translates as some are very good, but others………)
  • Distributors must identify groups of clients for which each fund type is NOT compatible (negative target market); how each client responds to ESG/Sustainability questions will enable advisers to match the responses to different approaches. This includes ensuring that clients who do not want ESG/Sustainable factors applied are not holding any funds that have been retrofitted.
  • Distributors to regularly review the funds they distribute and the services they provide, taking into account changes that may have a material effect on the target market; if you recommended any fund without a prior discussion of ESG and Sustainable Finance, all retrofitted funds may now be unsuitable.

Matters of sustainably

It’s not a reason to panic (any action here needs a well thought out approach to ensure customers are treated fairly!), but it is an area that firms need to start addressing now. Imagine a scenario where, the day after reading this article, you have an annual review meeting with a client and you agree to continue with the existing portfolio for another 12 months. There was no discussion of ESG, Sustainable, Responsible, Impact, SDGs or Ethical issues. If you cannot show where there has been any retrofitting of ESG/Sustainability to any of the funds, there is no way of being able to confirm that any of the funds remain suitable. Anyone undertaking a file review would have to class the file suitability as ‘uncertain’ at best. This is because:

  • The file won’t show whether an assessment was made on the funds for ongoing suitability. The file needs to show that the fund remit, strategy or investment processes have not changed.
  • The file won’t show whether the client wants or doesn’t want ESG, Sustainable, Responsible, Impact, SDGs or Ethical issues considered and therefore the adviser will have no idea what target market funds to recommend to the client.

About ESG Accord

ESG Accord provides a packaged compliance framework to firms so enable them to handle all ESG & Sustainability preference outcomes. This will increase your firm’s suitability outcomes, fund strategies will genuinely meet client needs and you’ll be meeting your PROD requirements as a distributor. Trust and transparency are increased, and the client is more engaged. For more information contact:

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