In a number of Member States, the Markets in Financial Instruments Directive (MiFID) brings in for the first time detailed product governance requirements for investment firms that manufacture or distribute financial instruments or structured deposits. The requirements are also relevant for investment firms offering or recommending products manufactured by firms not captured under MiFID II.
In particular, manufacturers must ensure that products are manufactured to meet the needs of an identified target market of end-clients, that its distribution strategy is compatible with the target market, that it takes reasonable steps to ensure that the products are distributed to the identified target market, and that it periodically reviews the identification of the target market and the performance of the products. The product governance requirements are wide-ranging and cover all aspects of the product design, change and monitoring process, including effective controls, stress testing, analysis of potential conflicts of interest, consideration of potential impact to the orderly function of the market, identification of the target market, appropriately aligned distribution strategy, appropriate product information, appropriately trained staff, and so on.
Investment firms that distribute products other than their own must have appropriate arrangements to obtain and understand relevant information on the product approval process, including the identified target market and the characteristics of the product. This requirement is in addition to the appropriateness and suitability requirements with which the firm must comply. For financial instruments issued by non-MiFID firms, distributors must have appropriate arrangements to obtain sufficient information about the instrument.
ESMA’s advice to the Commission on Level 2 rules took into consideration three existing policy documents: 'Manufacturers’ Product Oversight and Governance Processes', issued in November 2013 by the three European Supervisory Authorities (ESAs); 'Regulation of Retail Structured Products', issued in December 2013 by IOSCO; and ESMA’s opinion of March 2014 on 'Structured Retail Products – good practices for product governance arrangements'. Although these were issued a year or so ago, many firms may not have reviewed their product governance and processes against these policy statements, perhaps in part because national regulators have not all actively engaged with firms about their product processes. MiFID II will force firms to undertake a thorough review and will require the national regulators actively to supervise firms in this regard.
ESMA’s advice acknowledges that many products can be considered compatible with the mass retail market. Therefore, the target market may be very wide and generally described. However, ESMA goes on to say that 'for more complicated, less mainstream products, such as convertible securities or structured products with complicated return profiles, the target market should be identified in more detail'.
It is now for the Commission to decide on the shape of the final Level 2 measures, expected by June 2015.
Banks are caught by the requirements, as are all forms of distributors. All UCITS and AIF managers, even if not directly subject to MiFID, will also have to review their product governance processes because the distributors will be required to seek information from the managers. Insurance companies are not caught be these requirements, but it remains the Commission’s intent to align the Insurance Mediation Directive with MiFID II.
Firms must be in full compliance by January 2017.