ESMA Pushes for Proportionate Oversight of MiFID II Sustainability Rules During ESG Transition Period

Key Takeaways

• ESMA Calls for Proportionate Oversight: The European Securities and Markets Authority urged national regulators to focus on dialogue and supervisory engagement rather than enforcement as firms continue implementing MiFID II sustainability requirements.
• Uneven Industry Progress Remains: A Europe-wide supervisory review found firms have made meaningful progress integrating sustainability preferences into investment advice and product governance processes, though implementation remains inconsistent across jurisdictions.
• ESG Suitability Challenges Persist: ESMA identified recurring issues involving client questionnaires, sustainability preference collection, ESG product categorisation, portfolio approaches, and recordkeeping practices.
• Regulatory Complexity Driving Caution: ESMA acknowledged that ongoing revisions to the EU sustainable finance framework, including SFDR reforms, are creating operational complexity for firms and investors alike.
• Framework Simplification May Follow: Findings from the supervisory exercise could inform future updates to MiFID II sustainability rules and ESMA guidelines aimed at making the framework more practical and consistent.

Deep Dive

In a statement released Tuesday, ESMA published the results of a Common Supervisory Action examining how investment firms and credit institutions have integrated sustainability considerations into suitability assessments and product governance frameworks under MiFID II. The review, conducted alongside national competent authorities throughout 2024 and 2025, paints a picture of an industry still working through the practical realities of embedding ESG preferences into investment advice.

The regulator said firms have made tangible progress since the sustainability amendments to MiFID II Delegated Acts took effect in 2022, but implementation remains uneven across the European Union and European Economic Area.

Rather than pushing for aggressive enforcement during a period of ongoing legislative reform, ESMA is now encouraging national regulators to prioritize engagement with firms and foster dialogue where shortcomings are identified, except in cases involving clear breaches or mis-selling.

The tone reflects a growing recognition inside European regulatory circles that the sustainable finance framework (spanning MiFID II, the Sustainable Finance Disclosure Regulation, and broader Retail Investment Strategy reforms) has become increasingly complex for both firms and retail investors to navigate.

Firms Still Grappling With Sustainability Preferences

One of the clearest themes emerging from the supervisory exercise was the difficulty many firms continue facing when attempting to translate highly technical sustainability concepts into language clients can meaningfully understand.

According to ESMA, firms reported persistent challenges explaining the regulatory definition of “sustainability preferences,” which relies on concepts tied to taxonomy alignment, sustainable investments under SFDR, and Principal Adverse Impacts.

Some firms attempted to simplify matters by avoiding technical terminology altogether, while others supplemented legal language with explanatory materials, interactive questionnaires, hyperlinks, and educational tools designed to help clients navigate unfamiliar ESG terminology.

The review found that firms have increasingly moved toward more detailed sustainability questionnaires compared with the early implementation phase of the rules. Still, ESMA noted that the level of granularity varies considerably across firms and jurisdictions.

In some cases, firms were found to collect sustainability preferences only for ESG products already available within their own product offerings, reflecting broader market limitations and continuing shortages of certain sustainable investment products.

The regulator also highlighted deficiencies in how firms handled clients who either declined to express sustainability preferences or merely expressed broad interest in sustainability without specifying detailed preferences. In several jurisdictions, firms failed to treat such investors as “sustainability neutral” as outlined in ESMA guidelines.

Questions also emerged around the neutrality of some client engagement processes. ESMA said certain disclaimers and questionnaire structures risked influencing client decisions rather than neutrally assessing investor preferences.

ESG Product Categorization Remains Inconsistent

The supervisory action also exposed ongoing inconsistencies in how firms categorise financial products with sustainability characteristics.

While most firms have introduced policies and procedures aimed at mapping ESG features of investment products, approaches differ substantially depending on business models, available data, and product offerings.

Some firms rely heavily on SFDR classifications, while others incorporate broader methodologies tied to Principal Adverse Impacts or other sustainability indicators. ESMA noted that inconsistent manufacturer disclosures and ongoing ESG data limitations continue to complicate firms’ efforts to reliably match products with clients’ sustainability preferences.

Importantly, the regulator stopped short of demanding excessive precision in areas where underlying ESG data remains unreliable or incomplete.

Instead, ESMA said firms may apply proportionate categorisation methodologies provided they remain consistent, documented, and sufficient to support MiFID-compliant suitability assessments.

The regulator also acknowledged that products with sustainability features falling outside the SFDR framework continue to present challenges, with firms adopting widely differing methodologies to assess those products.

A Transitional Moment for Sustainable Finance Rules

The findings arrive as European policymakers continue reworking major pieces of the EU sustainable finance framework in an effort to simplify disclosure obligations and improve usability for investors.

ESMA said the expected review of SFDR could eventually lead to clearer sustainability-related product disclosures, which in turn may require future adjustments to MiFID II sustainability preference rules.

The authority indicated that insights gathered through the Common Supervisory Action may feed into future revisions of MiFID II Delegated Acts and related ESMA guidelines with the goal of reducing unnecessary complexity while promoting more consistent application across the market.

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