MiFID II investor protection

Years in the making, MiFID II will finally be implemented on 3rd January 2018. The regulation covering investor protection remains a key area of uncertainty even at this late date. Within investor protection the rules around product governance, costs and charges and research unbundling have proved the most difficult to decipher.

The first step to clarification should be the detailed understanding of the new product governance regime. If an investment firm succeeds in understanding and mapping their distribution chain, standardising their product data, assessing the target market and distribution strategy by product – they will not only be on track to a successful MiFID II investor protection implementation, but also add value to their offering in the longer term.

Target market assessment – do not underestimate the size of this piece of work!

Under MiFID II product governance regulation, target market assessment must be carried out by firms who manufacture and distribute products – the manufacturer’s target market being the conceptual target end-client and the distributer’s target market adding information on their own clients to the manufacturer’s assessment. The Level 3 guidelines require the product’s distribution strategy to be identified and communicated along with the target market from manufacturer to distributer. The product governance regulation should be applied in an appropriate and proportionate manner, taking into account the nature, scale and complexity of a firm’s business and the range of financial services and activities.

Distributers are obliged to provide manufacturers with feedback on product performance and sales outside of the target market (with exceptions for sales for the purposes of hedging or portfolio diversification).

Building blocks to success

Back in October 2016, ESMA published draft guidelines on product governance. They published their ‘Final Guidelines on Product Governance’ on 2nd June, 2017 – these focus specifically on target market assessment and feedback from distributers. Firms should now be clear on what is required and take the key steps to implementation.

The building blocks of product governance are key to the successful implementation of all of the processes involved in the pre-sales process – including costs and charges, disclosure of information to clients, suitability and appropriateness and inducements.

The regime focuses on the identification and assessment for each product of the target market and the distribution strategy. The regime can be applied proportionately depending on the complexity of the product and the sophistication of the end-client.

Key building blocks are:

Preparatory work
Catalogue products simple to complex
Apply the product governance regulations proportionally
Understand whether a manufacturer, distributor or both
KYC Categorise clients according to MiFID II
Agree approach to existing products – transitional arrangements
Transitional arrangements
Identify & assess target market for the back book if agreed as transitional arrangement
Communicate back book target market, distribution strategy & information re the product approval process to distributers
Set up the target market template and agree product performance MI required from distributers
Define the target market framework and distribution strategy template (EMT framework)
Define the feedback information required from distributers
KYC revise all distributer contracts to include data/information flow responsibilities
Agree management Information required for regular reviews and set up KPI mechanism
Agree and build mechanism to facilitate information flow manufacturer/distributer/manufacturer
Assess, test and approve new products (and significant adaptations to existing products)
Run scenario analysis/stress tests for each product in the proposed target market
Assess target market risk and align distribution strategy accordingly
Assess product characteristics and impact on market stability
Ensure that products meet the needs (not wants) of the target market
Identify negative target markets
Communicate product target market, negative target market, proposed distribution strategy and information re the approval process to distributers/intermediaries
Regular review of product performance in the target market
Receive product performance information from distributers
Run KPIs/management information for management body review
Review regularly products performance to ensure appropriate alignment with target market
Assess for signs of product illiquidity or volatility
Adjust target market and communicate to distributers as necessary
If significant adaptations to the product are agreed, revert back to product approval process
Ensure prevention of conflicts of interest including remuneration in relation to product governance
Agree revised process for product approval for all instruments and significant adaptations
Ensure that management body has “effective control” over product approval process
Compliance function must oversee and approve product governance
Ensure that staff have appropriate training & expertise (L3 guidelines)
Ensure that management information/KPIs are available to the FCA
Ensure that complaints procedures are in place and communicated

Major challenges include

i. Removing ambiguity. “Standardisation of the target market into clear, unambiguous categories to facilitate scalable electronic communication and a common understanding across the industry.”

Source: p3 Manufacturer/Distributer Industry Target Market Working Group – response to ESMA Consultation Paper on the Draft guidelines on MiFID II Product Governance requirements.

ii. Understanding the Manufacturer-Intermediary-Distributer chain. It will be imperative that firms understand and map the distribution chain –from manufacturer via intermediary to distributer and final end-client. Clear understanding of the obligations of each party will be essential

How Holley Holland can help.

We can help clarify what the MiFID II investor protection requirements mean for your specific product range.

If you a manufacturer, distributer or intermediary, we can assist you in understanding your investor protection responsibilities. 

Do you understand how you will communicate information to clients/distributers ‘in good time’? We can help.

Our services

  • Workstream/project re-focus;
  • Programme support – subject matter expertise, sanity check, prioritisation and implementation planning
  • Business readiness – liaison with BAU functions;
  • 3rd party supplier management;
  • Bespoke technical solutions
  • Focus on investor protection – getting the building blocks right (complex/non-complex products; manufacturer/distributer; target market; distribution strategy RTO vs advised; KYD and KYC; standardisation of product, client and employee data)
  • Accelerated impact analysis;
  • Workshop facilitation – Level 3 guidelines, Q&A, etc.