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The product governance regime started seven years ago, addressing governance concerns in the high-risk retail structured products market. Since then the FCA has issued several more guidance notes and policy papers, including on the use of the temporary product intervention rules and on the responsibilities of providers and distributors for the fair treatment of customers (RPPD). The latest post-MiFID II ‘PROD’ rules are a natural extension to these, but as rules rather than guidance. As a result, they have sparked debate. Both manufacturers and distributors should assess how the rules apply to their business and whether they need to make any changes.
Preparing the target market – what are your obligations?
At the heart of the product lifecycle process is the requirement to identify a target market in relation to all products and services that you offer. ‘Products’ are defined as MiFID financial instruments including structured products. ‘Services’ are defined as MiFID services such as portfolio management.
Whether you’re a firm that manufactures products (creates, develops, issues or designs), or a firm that distributes products (offers, recommends, sells), you are affected. You must maintain, operate and periodically review a process for the approval or distribution of all products and services that you offer to clients. If you’re providing an investment management service to your clients, then you are deemed to be a distributor of that service and are caught by the distributor rules.
The rules also require you to implement, a product approval process enabling you to identify and regularly assess your clients for each of the products or services that you create or offer them. The ESMA guidelines set out five different criteria that both the manufacturer and distributor must consider when identifying the target market – client type, knowledge and experience, financial situation, risk tolerance, clients objectives and needs.
Product governance for manufacturers and distributors
Both manufacturers and distributors must consider to whom the product or service shouldn’t be sold – the so-called negative target market. The ESMA guidelines do allow you to sell products or services into the negative target market, but only in specific circumstances such as where the client is investing for hedging purposes or as part of a diversified portfolio.
If you’re a distributor then you must report sales into the negative target to the manufacturer. It’s then up to manufacturers to decide whether to take remedial action based on the sales information they receive.
If you’re a manufacturer you must:
- assess the target market for your products or services against the ESMA categories
- define your distribution strategy and align this strategy against the identified target market. (For example the distribution strategy might include selling the product through an online execution-only service.)
You can take a ‘proportionate approach’ when applying the product governance rules – for the target market identification exercise this means you should prepare a more detailed target market assessment for more complicated products, such as structured products, and less detail is required for simpler, mass-market products, such as non-complex UCITS funds.
If you’re a distributor you must:
- create your own target market using the same five ESMA criteria and combine information provided by the manufacturer
- have appropriate oversight of the products you intend to offer, to ensure that they are aligned with the type of service you provide.
(For example, as a distributor you’re unlikely to sell complex products to clients under an execution-only service.)
How we can help
Whether you’re a manufacturer or distributor, we can help you to apply the product governance rules to your business:
Target market assessment
The target market assessment needs to be detailed enough to allow you, as a manufacturer or distributor, to identify when a product or service is not compatible with a certain type of client. If you’ve not yet carried out a target market identification exercise for each of your products or services, we can help you get it done.
Target market validation
Where you’ve already completed one, we can help you to validate whether, in practice, the business is delivering into the target market, by assessing the controls you have in place as well as the products and services being distributed.
Product governance health check
Using our MiFID II health check tool we can review how you’ve implemented the product governance obligations using a set of questions that focus on key activities – including testing your compliance with the rules around target market identification. We’ll let you know how you’re doing against your peers and highlight any areas that need further work.
