UniCredit reply to ESMA Consultation Paper on the Draft guidelines on MiFID II product governance requirements

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1 5 January 2017 FOR PUBLICATION UniCredit reply to ESMA Consultation Paper on the Draft guidelines on MiFID II product governance requirements Introductory remarks UniCredit is pleased to provide comments on the ESMA s ESMA Consultation Paper on the Draft guidelines on MiFID II product governance requirements. As a Pan European Commercial Bank delivering unique Western, Central and Eastern European network to extensive Retail and Corporate client franchise, with a CIB business plugged into Commercial Banking to enable cross-selling and synergies across business lines and countries, UniCredit considers crucial that the definitive Guidelines will be sufficiently flexible so as to be adaptable to different businesses, clients, and products, taking in due consideration any distribution strategies put in place. More in detail, we support the European lawmakers intention to introduce obligations for manufacturers and distributors in connection with the creation, design and development of financial instruments, including the determination of target markets and appropriate distribution channels as well as the review of products and their distribution in order to ensure a higher level of investor protection. At the same time, we are concerned that the implementation of MiFID II could lead to disproportionate burdens for manufacturers and distributors and to unnecessary constraints on the range of financial instruments the investor can access. We are particularly concerned that the already extensive regulatory requirements under MiFID II (including the Level 2 measures) might be interpreted even more extensively on Level 3. Responses to selected questions of the Consultation Paper Q1: Do you agree on the list of categories that manufactures should use as a basis for defining the target market for their products? If not, please explain what changes should be made to the list and why For the purpose of giving investors access to a broad range of financial instruments, the target market criteria should be standardisable meaning that they should be conceived in a way to enable an automated communication between manufacturer and distributor through standard (ISIN-) data fields. A pure manual process is not possible considering the huge numbers of different products available in the market. For this purpose enabling a standardization of the Target Market criteria (i.e. uniform subcategories, values) should be seen as key part in the MiFID II implementation. Either from manufacturer s side and distributor s perspective, we also recommend: to match the category of Clients Objectives with the holding period of the investment and not with other characteristics like liquidity supply or retirement provision, taking in due consideration that the holding period is anyway the main feature together with the risk profile to identify the financial characteristics of the investment; to delete the category of Clients Needs considering that: 1

2 - the set required by the other categories already allows a clear and complete identification of the target market in terms of "needs" of end customers; - the further declination of client needs with attributes such as, for example, green investments or ethical investment is disproportionate to the provisions of article 9 (11) of Commission Delegated Directive of , which requires in particular the consideration of the risk/reward profile of the product and not elements of the type above mentioned. We also underline that the identification of the categories Clients' Objectives and Risk Tolerance does not appear consistent with the approach adopted under Article 54 of the Commission Delegated Regulated of that, for the purposes of evaluating the suitability, considers risk tolerance as a sub-category of the customer's investment objectives, and not a category of its own. Consistently with all said above, we suggest to clarify that Objectives should be intended as Investment Objectives already considered for the suitability assessment, in doing so referring to both time horizon (see article 54.5 of the MiFID II Delegated Regulation) and risk tolerance (see also article 54.2.(a) of the MiFID II Delegated Regulation and the corresponding key information required for PRIIPs KID) as constituents of that (broader) criterion. Furthermore, only from the distributor s perspective, we do highlight that: - the consideration of financial situation with a focus on the ability to bear losses should be considered sufficient the use of loss generation indicator like, for example, limited, moderate, significant, and high potential losses; - for the identification of the target market, it should be sufficient to use the same criteria used for assessing suitability of investments because of the functional convergence between suitability and product governance. Please see Q3 for the case of banks / investment firms operating in appropriateness regime or with customers classified as professional clients or even in execution only regime. Q2: Do you agree with the approach proposed in paragraphs of the draft guidelines on how to take the products nature into account? If not, please explain what changes should be made and why. No particular comments provided Q3: Do you agree with the proposed method for the identification of the target market by the distributor? The detailed guidelines for Distributors (in particular, paragraphs 26 and 27) as well as the examples of the consultation paper seem to restrict the distribution of complex products exclusively via the investment advice service. This would significantly limit the leeway for banks / investment firms to set up their own distribution strategies as well as the product range available to self-guided investors, who are usually investing via on-line platform according to their knowledge and experience. There is a significant risk that those investors would seek for alternative solutions in non-mifid regulated jurisdictions. We would therefore appreciate, if it could be clarified that there is no automatic dependency between the complexity of a product and the distribution strategy (i.e. investment service & acquisition channel) to be used. Furthermore, to ensure a concrete definition of the target market assessment, it is worth mentioning that the existence of a relationship between the manufacturer and the distributor is an essential prerequisite for a proper and full application of the product governance rule. 2

3 Indeed, it should be considered that: (1) to establish a target market for all financial products made available to their clients, distributing banks / investment firms should take into consideration financial instruments negotiated in secondary markets potentially accessible by the client upon his/her request (via the so-called execution services, such as placement, execution and/or reception and transmission of client orders); (2) for such traded products there are in place appropriate price discovery and liquidity provision mechanisms already ensured by the trading venues / stock exchanges where they are negotiated (i.e. the reference has to be of course intended to official trading venues due to the prohibition of the so-called dark pools imposed by MiFID II itself); (3) distributing banks / investment firms would not have practicable tools or channels to make available the manufacturers about sales, as it would be required by article 10, paragraph 9, of the Delegated Directive; (4) subsequently, the manufacturer would not be in a position to fulfil requirements provided by article 9, paragraph 15, in particular letters f) and g) of the Delegated Directive regarding the obligation, upon occurrence of certain events affecting the product, of (i) contacting the distributor in order to discuss a modification of the distribution process or (ii) terminating the relationship with the distributor. In light of the above, we do believe that the Final Guidelines should further develop the application of the product governance rule in light of the proportionality principle inspiring the whole MiFID II legislative package by differentiating such an application to governable and accessible products provided that: governable products are those pre-selected for distribution by banks / investment firms through formal distribution agreements with the relevant manufacturers, where both the former and the latter's rights and duties are properly formalised and then recognizable; accessible products are instead those for which a specific distribution agreement is not in place like the case of products traded on the secondary market (e.g. ETFs, certificates, listed bonds, etc.). As particularly regards the accessible products, any target market assessment should be allowed in a simplified way due to the lack of direct relationship with manufacturers allowing distributors to use all necessary information to comply with a full product governance regime. Moreover, for the distribution through on-line platforms the target market assessment could be considered even as embedded in the distribution itself since it is based on client knowledge and experience. A different approach will dramatically increase operational costs related to assess / deep dive any products available on the accessed trading venues which may lead to a reduction of trades with distortive and negative effects on the general liquidity of the secondary market, detrimental even to the fair value determination. All that said, we deem that the relevant target market assessment: should take in due consideration the product liquidity ensured by the trading venues / stock exchanges where the secondary market products are negotiated (by the way, with lower transactional costs) significantly reduces any product complexity; could be referred to product families (i.e. essentially identified through main asset classes) rather than all specific products being negotiated; should consider also the specific distribution channels from time to time used by banks / investment firms to access the markets, bearing in mind what already recommended by several National Competent Authorities under the current MiFID I regime who have already assessed the on-line distribution as the most relevant channel for self-guided investors as well as the channel less influenced by conflicts of interest. 3

4 Finally, as anticipated in Q1, for banks / investment firms operating in (i) appropriateness regime (ii) with customers classified as professionals or even (iii) in execution only, the Guidelines could clarify that product governance obligations for distributors should refer only to client knowledge and experience. Q4: Do you agree with the suggested approach on hedging and portfolio diversification aspects? If not, please explain what changes should be made and why. Taking in due consideration what suggested above for the proportional application of the product governance rule, we do highlight that any distribution based on a portfolio approach should not be treated merely as an allowed deviation from a standard regime exclusively based on a single product approach. Contrarily the portfolio approach, on the one hand, ensures a full application of the product governance rule which will be grounded on a trilateral model (i.e. products, clients, and their portfolio) rather than on a bilateral one (i.e. only products and clients), and, on the other hand, is the key to reach an appropriate degree of portfolio diversification to benefit clients as already considered by ESMA in its 2012 Guidelines on certain requirements of the MiFID suitability assessment (under MiFID I). Paragraph 30 of the draft Guidelines background clarifies that the target market assessment, as provided by the manufacturer, is essentially focused on the individual product manufactured and, therefore, it cannot take into account the personal features of each potential client and, in particular, the general situation of his personal investment portfolio. The situation described above, from our point of view, does not properly take into account more recent and sophisticated developments in the operating model implemented by banks / investment firms to provide their clients with investment services, in particular the investment advice one. Many firms, in fact, are currently offering to their clients non-independent investment advice according to a portfolio approach, in which any recommendation issued takes into account not only the personal characteristics of the client (in terms of knowledge and experience in investments, financial situation, investment objectives, risk profile) but also the situation of his/her portfolio. This type of investment advice aims in fact at ensuring that the client's portfolio - considered as a whole - is the most consistent with the financial profile of the client. Therefore, the Final Guidelines should deal with the portfolio approach as standard approach to carry out the product governance assessment which should not be based exclusively on a comparison between the product features and client profiles. Indeed, we see a substantive benefit for the investor protection from promoting it instead of inhibiting. Coherently we also propose to delete the implicit concept that the target market assessment should be always based on a single product approach. Q5: Do you believe further guidance is needed on how distributors should apply product governance requirements for products manufactured by entities falling outside the scope of MiFID II? We believe that any further detailed guidance should be left to market standards defined by the banking industry. Q6: Do you agree with the proposed approach for the identification of the negative target market? In line with the feedback to question 3, we deem that the negative target market should not be relevant for self-guided investors. Q7: Do you agree with this treatment of professional clients and eligible counterparties in the wholesale market? 4

5 In this context a different treatment between born and elective professional clients in paragraph 72 should be deleted because there is no need to differentiate regarding the knowledge and experience since the process to elect a retail client to a professional client is based on the evaluation of sufficient knowledge and experience.. Q8: Do you have any further comment or input on the draft guidelines? In relation to product governance rules and the target market required by investment firms we would like that ESMA Guidelines take in to account the peculiarities of the portfolio management service. In our view this investment service cannot be merely considered as a form of distribution of financial instruments. Portfolio management aims at investing the client assets in accordance to the contractual mandate given by the client relating to the specific objectives of the portfolio management and its investment rules. Consequently, the portfolio manager does not market or offer financial instruments, but rather fulfils a complex investment service by purchasing and selling financial instruments in the name and behalf of the client through its mandate. It is therefore consistent with the specific nature of this investment service to conceive the product governance obligation at the portfolio level rather than the financial instruments to be purchased through the portfolio manager. In relation to the above, we believe that it would be necessary to reconsider the ESMA s proposal in paragraph 43 of the draft guidelines where it is said that if distributors intend to approach clients or potential clients in any way, to recommended or actively market a product or consider that product for the provision of portfolio management, it is expected that a thorough assessment of the target market is always conducted. Moreover, it s important to require that when the investment portfolio is distributed by a firm other than the investment firm that provides the investment portfolio service, the distributor should take in to account the potential target market defined by the investment manager and identify the effective target market based on the characteristics of its own clients. Q9: What level of resources (financial and other) would be required to implement and comply with the Guidelines (market researches, organisational, IT costs, training costs, staff costs, etc., differentiated between one off and ongoing costs)? If possible please specify the respective costs/resources separately for the assessment of suitability and related policies and procedures, the implementation of a diversity policy and the guidelines regarding induction and training. When answering this question, please also provide information about the size, internal organisation and the nature, scale and complexity of the activities of your institution, where relevant. The increase in costs (initial and recurrent) would be particularly relevant if the rules of product governance should be implemented on the basis of the current draft guidelines. 5