Product Governance and Funds. What is changing on the way to MiFID2. Mahrie Webb, Partner. Romeo Battigaglia, Partner. Caroline Hunter-Yeats, Partner

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1 Product Governance and Funds What is changing on the way to MiFID2 Mahrie Webb, Partner Romeo Battigaglia, Partner Caroline Hunter-Yeats, Partner October 2015

2 Agenda Summary of the key Product Governance requirements under MiFID2 Review of FCA views on Product Governance for retail structured products Overview of the Italian CONSOB recommendation on Complex Products (including funds) How can recent UK and Italian experience help with preparations for MiFID2? 1 / B_LIVE_EMEA1: v1

3 What is Product Governance under MiFID2? Brand new for MiFID2 and key priority for FCA in the UK Requirements on firms to maintain, operate and review product governance and approval processes Detail different for manufacturers and distributors Overall intention: Investment products to be designed to meet the needs of an identified target market Distribution strategy to be compatible with the identified target market Products only offered/recommended if firm has understanding of the product and it is in the interests of the client/investor to do so. Not limited to retail products 2 / B_LIVE_EMEA1: v1

4 Product Governance Are you a manufacturer? Broad definition of manufacturer that captures all investment firms that create, develop, issue and/or design investment products Impact on: UCITS and Mancos AIFs and AIFMs Potential changes to AIFMD and UCITS Directive UK retail product providers Responsibilities of providers and distributors for the fair treatment of customers ( RPPD ) 2007 FCA Thematic Review on post authorisation review of funds Business Plan 2015/16 3 / B_LIVE_EMEA1: v1

5 Product Governance Key obligations for manufacturers Procedures and measures to ensure design of product does not adversely affect client or cause problems with market integrity Management body to have effective control over product governance process Identify target market on a theoretical basis, analyse why the product is compatible with the target market and determine investors for whom the product would not be compatible Scenario analysis which test the risk of poor investment outcome and circumstances which may cause such outcome Consideration of charging structure given characteristics of target market Product review for any re-launch or further issue to ensure remains compatible with objectives, needs and characteristics of target market Identify and take action if event occurs that affects the potential risk and return expectations 4 / B_LIVE_EMEA1: v1

6 Product Governance How does a manufacturer identify its target market? On a theoretical basis without any specific knowledge of individual clients but should be able to identify client types whose needs, characteristics and objectives are compatible with the product Also need to identify groups of investors for whom the needs, characteristics and objectives are not compatible Use of knowledge of the financial markets and past experience with similar products and investor groups Less detailed analysis required for simple mainstream products more detail required for complicated, less mainstream investments? Retail/Professional? Execution only/advised? Tax status? Jurisdiction? 5 / B_LIVE_EMEA1: v1

7 Product Governance Are you a distributor? An investment firm which offers and/or recommends investment products and services to clients. Offer very broad. Consider specific channels/structures: EU based global distributors Sub-distributors Wealth managers/financial advisers Platforms Life companies selling unit-linked products Discretionary managers 6 / B_LIVE_EMEA1: v1

8 Product Governance Key obligations for distributors Distributors should use the manufacturer s more general target market assessment together with existing information on their clients to identify their own target market for a product Ensure they have in place adequate product governance arrangements to ensure product and services they intend to offer are compatible with the client. Plus arrangements to comply with other COB rules (conflicts, suitability, inducements etc.) Ensure that management body endorses the range of investment products and services that will be offered and the respective target markets. Compliance must oversee the development and review of the products governance arrangements Provide manufacturer with sales information to ensure manufacturers can carry out product reviews Consideration of charging structure given characteristics of target market Periodically review and update product governance arrangements to ensure they remain fit for purpose and robust 7 / B_LIVE_EMEA1: v1

9 Product governance Distributing products manufactured by out-of-scope firms Obtain product information of reliable and adequate standard to ensure product distributed in accordance with characteristics, objectives and needs of target market If such product information not publicly available, then enter into agreement with manufacturer and/or agent for provision of information Where there is a chain of distributors, the final distributor (ie the firm with the direct client relationship) has ultimate responsibility to meet the product governance obligations Intermediate distributors must apply the product obligations for manufacturers, as relevant, in relation to the services they provide 8 / B_LIVE_EMEA1: v1

10 UK Retail Structured Products - Product Governance July 2007: Responsibilities of providers and distributors for the fair treatment of customers ( RPPD ) October 2009: TCF review of Retail Structured Products March 2012: FCA Product Governance Finalised Guidance November 2013: FCA thematic review of 7 leading sell-side firms on their retail structured products January 2015: FCA Consumer Spotlight March 2015: FCA Thematic Review on retail structured products FCA Occasional Paper 2 plus 2 makes 5? We will carry out a thematic review of firms product governance practices to ensure that the outcome is appropriate to the consumer. We will take tough action if standards are not adequate FCA Business Plan 2013/ / B_LIVE_EMEA1: v1

11 Product Governance: FSA Guidance, March 2012 Post sales responsibility - Business models - Product approval process - Selection and monitoring of distribution channels - Point of sale disclosure PRODUCT LIFE CYCLE Identification of target market Stress testing and modelling Product design & development 10 / B_LIVE_EMEA1: v1

12 Challenges in the UK Structured Product Market Pure manufacturer/retail manufacturer Target market: How granular? Is consumer testing required? Diligence on distributors: Challenges with private wealth/plan managers? Stress testing: How, when, who, shown to whom? Extraterritoriality Monitoring product lifecycle / MI 11 / B_LIVE_EMEA1: v1

13 Overview of the Italian CONSOB recommendation on complex products (including funds) The aim of the CONSOB Communication (97996/14, dated 22 December 2014) is to increase the level of protection of retail customers. The Communication follows two European Securities and Markets Authority ( ESMA ) opinions concerning MiFID practices for firms selling complex products of 7 February 2014 and Good practices for product governance arrangements of 27 March Key points: Scope of application List of complex products black and grey list (which includes funds) CONSOB recommendations CONSOB Q&A dated 23 June / B_LIVE_EMEA1: v1

14 What funds are affected Alternative funds (letter ix of CONSOB list). Funds whose pay off is linked to indexes which are not complying with ESMA guidelines dated 18 December 2012 for ETF (letter vii of CONSOB list). Funds using leverage above 1 (letter xi of CONSOB list) this includes all funds allowing taking short positions and funds linked to indexes using leverage does NOT include funds using leverage exclusively for hedging purposes or as a matter of efficiency in the relevant portfolio management, provided it does not result in the exposure to risks altering the risk/reward profile of the fund. Structured funds as defined under article 36 of EU Regulation 583/2010 (letter xii of CONSOB list). 13 / B_LIVE_EMEA1: v1

15 What to do 1 Target market Identifying for each complex product the potential target market conducting due diligence to understand needs, objectives and knowledge of the financial instrument. Taking into account need of liquidity and holding period to identify the target market. 4 Product design Where structuring a complex products, focusing on financial needs, investment objectives, knowledge and experience of the tarket market. Involving the Compliance function in the product design process. 2 Product testing Evaluating past performances and preparing future performance scenarios for the purpose of testing if the products correspond to clients needs. Making available the results of products testing to distributors. 3 Value and cost transparency Providing clients with information about costs (unbundling of costs). With specific reference to those funds captured by the Communication, the intermediary shall also consider whether its features suggest providing clients with information additional to those included in the relevant KIID, also extracting them from the fund s prospectus. 5 Reviewing/Adopting Policies Reviewing/adopting policies and procedures consistent with the distribution strategy and remove/avoid remuneration practices making more rewarding the distribution of complex products (When is it possibile to sale complex products? What are the risks? What are the rules governing the remuneration?). 6 Immediate Actions Implementing as soon as possible those decisions and measures communicated to CONSOB. With specific reference to funds, it is the distributor the one required to assess the specific features of the product (also in consultation with the product provider). 14 / B_LIVE_EMEA1: v1

16 How recent UK and Italian experience can help with preparations for MiFID2 Get prepared follow the guidance KYTM a change of mindset Be prepared for commingling of responsibilities between distributors and manufacturers Learn lessons from Thematic Reviews Remember that product governance is a circle don t ignore post sale reviews Consciously risk manage your cross border challenges Accept that it is the end of the golden age for UCITS in Italy 15 / B_LIVE_EMEA1: v1

17 Simmons & Simmons MiFID2 expert resources Complex regulation made easy Our dedicated MiFID2 expert resources include: Our new subscription service the MiFID2 Manager sets out the practical steps that need to be taken to stay on top of the requirements of MiFID2/MiFIR and its implementing legislation The MiFID2 Tracker on elexica is a helpful tool to track and access all the legislative measures introduced under MiFID2. It also includes articles and publications on the topic Our international MiFID2 Bite size call series provides updates on new developments and considerations in the lead up to its implementation 16 / B_LIVE_EMEA1: v1

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