Something of nothing – or a radical shift in product development?

The run up to the 3^rd January deadline for MiFID II felt less like a mad dash for the finish line and more like a headless chicken race. I think we can safely say no firm was entirely ready and therefore in 2018 there will continue to be lots of work to do. The FCA has indicated that best efforts and “work in progress” will be tolerated as long as transaction reporting is right. Which leads me to wonder, how the new requirements of product governance might develop as we all learn to adapt in the post MiFID II world?

One delegate from a recent MiFID II awareness session that I ran (albeit they worked in a retail environment) described this as “something of nothing”. However other work that I undertook with an Asset Management house said they had been working on this for months in the run up to January. So what is changing? Every product is now required to have a stated target market and this applies to firm who manufacture products and to the firms who are subsequently distributors of those products. After 3 January 2018, any existing products which are still being distributed will need to be assessed in terms of the following requirements at their next product review. Any new products need to be designed with these requirements in place from day one.

 

Every product is now required to have a stated target market

Target market assessments apply to ‘end clients’ which would mean that professional clients or eligible counterparties who intend to on-sell a product are not the ‘end client’. In this scenario, the professional client or eligible counterparty would be acting as a distributor and would need to comply with the product governance requirements. Distributors include advisers and wealth managers and they will be obliged to monitor all investment placements and analyse how it aligns to the product manufacturers’ designated target market. Additionally distributors will be required to advise manufacturers when they distribute outside of the target market and manufacturers will need to consider whether or not they allow the distributor to continue distributing their products?

These are the 6 categories identified by ESMA.

1. The type of clients to whom the product is targeted – specification should at least be made according to MiFID II client categorisation, although additional descriptions may be used to refine the clients.
2. Knowledge and experience – the firm should specify which knowledge the target clients should have about elements such as the product type, product features and / or knowledge in thematically related areas that help to understand the product.
3. Financial situation with a focus on their ability to bear losses – the firm should specify the amount of losses a client is willing and able to afford (which can be expressed as a percentage of net investable assets).
4. Risk tolerance and compatibility of the risk/reward profile of the product with the target market – ESMA suggests that basic risk attitudes should be categorised (and give the examples of ‘risk orientated’, ‘balanced’ or ‘conservative’). ESMA notes that different firms in the product chain may have different approaches to defining risk so it is important that a firm is explicit about the criteria that must be met for each category.
5. Clients’ objectives – the firm should specify the investment objectives of target clients and ESMA gives the examples of references to liquidity supply, retirement provision or the number of years the investment is to be held.
6. Clients’ needs – MiFID II introduced the concept of ‘needs of an identified target market of end clients’ and so the firm should specify aspects of the investment and expectations of targeted clients.

So these are all very familiar concepts to those in retail but less so in the institutional space. How will this be translated by the Asset Managers and how aligned will they all be? A “watch this space” issue for 2018, I suggest.