Some are struggling with rules brought in by Mifid II and the FCA is expected to sharpen its focus on this area
It is well over a year since the introduction of Mifid II, yet the fallout continues, with intermediaries still getting to grips with the implementation of aggregated costs and charges disclosure requirements.
Issues with transaction reporting and tighter rules on inducements linger, while other matters expected to have caused debate, such as the new definition of independent advice and the introduction of telephone recording, have passed by with little comment.
Initially, it seemed the introduction of product governance rules had also slipped under the radar but, in recent months, they have come to the fore.
In fact, this is an area in which the regulator is expected to sharpen its focus this year. So let’s look at some of the main questions still being asked by advisers.
Which firms are manufacturers and which are distributors?
Product manufacturers are firms that design, create, develop and issue financial instruments or insurance products; in simple terms, product and fund providers.
Distributors are firms that offer or sell investment or insurance products and services to clients.
Advice firms and discretionary fund managers will be distributors in this context, although the latter could also be classed as manufacturers. Where the DFM service is wrapped within a product structure (for example, a unitised model portfolio service), the requirements for product manufacturers will apply to the product in question.
What is product governance?
Product governance is the term used to describe the process of designing, approving, marketing and providing ongoing management of a financial product throughout its life cycle.
The obligations apply to Mifid investment products such as unit trusts, open-ended investment companies, and investment trusts and services. The Insurance Distribution Directive also introduced governance requirements for insurance products.
It is the responsibility of manufacturers to ensure their products are designed to meet the needs of an identified target market, and that their distribution strategy is consistent with this. This target market information must be communicated to distributors.
Manufacturers must also identify and communicate to distributors any client groups for which their products are not compatible. This is known as the negative target market.
Target market data may also be obtained through third-party research tools or via investment platforms. Platform providers should obtain relevant target market information and present it to users.
What are the responsibilities of distributors?
Distributors must assess the needs of their clients and the compatibility of each product, taking into account the target market information identified by the product manufacturer.
To this end, distributors must also ensure staff involved in the distribution of the relevant products have the appropriate knowledge and competence to understand the nature and risks of each one.
This is nothing new and should not present a challenge. Existing training and competence requirements, and internal standards and testing for relevant non-advising staff, should cover this comfortably, as long as documentation is thorough and kept up to date.
What steps can you take to meet obligations?
Client segmentation is an effective way of defining your target markets. This is about establishing the types of clients you have, and what services and products are – and are not – suitable for them. Criteria worth considering for this exercise could include:
- Client type (retail or professional);
- Life stage (accumulation, consolidation, planning for retirement, decumulation);
- Knowledge and experience;
- Ability to bear financial loss;
- Risk tolerance;
- Client needs (such as investment term, objective, protection/growth of capital, or future income need).
Having defined the different segments that make up your client base, you need to define the services and solutions you will offer to each.
Just make sure you have the systems and processes in place to deliver them.
Your centralised investment proposition must be aligned to the needs of your target clients.
It is important to have a clearly defined and repeatable process to perform this task.
For this reason, we recommend that, where possible, you establish an investment committee (or similar body).
The role of an investment committee is to provide a defined framework for centrally overseeing your firm’s investment process, including product and fund approval, and keeping those selections under review.
An investment committee is also the ideal forum for overseeing your selection of insurance products.
As with all processes, it is vital decisions are appropriately documented.
Using the investment committee terms of reference and minuted decisions is one way to achieve this.
Clearly, you still have to demonstrate suitability on an individual-case basis, but a product governance structure needs to sit above your advice or investment management processes to support your firm’s investment choices as a whole.
Jon Roberts is compliance policy consultant at Threesixty