mifid ii academy: product governance - norton rose … ii academy - product governance ... •when...

MiFID II Academy: Product Governance

Norton Rose Fulbright LLP

Floortje Nagelkerke

28 March 2017

Introduction

Dutch transposition

MiFID II Academy - Product Governance - 28 March 2017

MiFID II implementation

• Article 93 MiFID II: Member States shall adopt and publish, by 3 July 2016, the laws, regulations and administrative provisions necessary to implement this Directive

• Act implementing the Markets in Financial Instruments Directive (recast) (2014/65/EU) (MiFID II) (Wet implementatie richtlijn markten voor financiële instrumenten 2014)

– Consultation on draft implementation act between in Summer 2015.

– Revised draft implementation act published in October 2016.

• Decree implementing the Markets in Financial Instruments Directive (recast) (2014/65/EU) (MiFID II) (Besluit implementatie richtlijn markten voor financiële instrumenten 2014)

– Implementation decree published for consultation on 23 March 2017, implementing MiFID II and (i) the Delegated Regulation supplementing MiFID II as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of the Directive and (ii) the Delegated Directive supplementing MiFID II as regards the safeguarding of financial instruments and funds, product governance obligations and inducements.

– The implementation decree contains implementing provisions of rules regarding product governance, which will primarily be implemented in the Decree on Conduct of Business Supervision of Financial Undertakings (Besluit Gedragstoezicht financiële ondernemingen) (articles 31b, 32 – 32c Bgfo Wft) and a number of other decrees.

• How to stay informed:

– AFM MiFID review page - https://www.afm.nl/nl-nl/professionals/onderwerpen/mifid-ll

– http://www.regulationtomorrow.com/the-netherlands/

– http://www.nortonrosefulbright.com/knowledge/technical-resources/pegasus/norton-rose-fulbright-briefings-slides-and-webex-recordings/

– http://ec.europa.eu/finance/securities/isd/mifid2/index_en.htm

– http://www.esma.europa.eu/page/Markets-Financial-Instruments-Directive-MiFID-II

– https://www.internetconsultatie.nl/mifidii_besluit

3

https://www.afm.nl/nl-nl/professionals/onderwerpen/mifid-ll






http://www.regulationtomorrow.com/the-netherlands/




http://www.nortonrosefulbright.com/knowledge/technical-resources/pegasus/norton-rose-fulbright-briefings-slides-and-webex-recordings/



















http://ec.europa.eu/finance/securities/isd/mifid2/index_en.htm

http://ec.europa.eu/finance/securities/isd/mifid2/index_en.htm

http://www.esma.europa.eu/page/Markets-Financial-Instruments-Directive-MiFID-II












https://www.internetconsultatie.nl/mifidii_besluit

https://www.internetconsultatie.nl/mifidii_besluit

Product governance

Product governance: source and scope

• Source of legislation:

– Recital 71 MiFID II;

– Article 9(3) MiFID II;

– Article 16 (3) MiFID II, paragraphs 2-6;

– Article 24 (2) MiFID II;

– ESMA’s technical advice (19 December 2014), paragraph 2.7; and

– Delegated Directive adopted by the Commission on 7 April 2016: recitals 15-20 and Chapter III (Product Governance Requirements)

– ESMA’s consultation paper containing draft guidelines on MiFID II product governance requirements (5 October 2016) – primary focus on target market assessment

• Applicable to all investment firms with establishment in the EEA (and its EEA branches) and to branches in the EEA of non-EEA entities, and UCITS managers and AIFMs when they offer individual portfolio management and investment advice

• Applicable in relation to all types of clients (retail, professional and eligible counterparties)

• Applicable to all financial instruments, including structured deposits

MiFID II Academy - Product Governance - 28 March 2017 5

Where are we?


Level 1

• Finalised and published in OJ

• Local Dutch implementation needed, only legislative proposal

Level 2

• Finalised but not yet published in OJ

• No changes expected

• Local Dutch implementation needed, only consultation

Level 3

• ESMA consulting on guidelines for target market assessment and transitional arrangements

Impact


• Senior management accountability – increased MI;

sign off on product approval policy; effective compliance

monitoring arrangements

• Assess human resource involved in the creation of

products – they must be experts

• Need for more market research / behavioural economics

to know what customers want?

• Implement pre-sale approval process in line with

requirements

• Implement post-sale review process – frequent review

(which will different by products) and ad hoc review.

• All distribution channels to be re-assessed

and re-categorised

• Contracts with distributors to be renegotiated

• Contracts with co-manufacturers to be negotiated

Product governance: current regime

• There are no existing detailed provisions regarding product governance or sales processes in MiFID I; only high-level organisational requirements in the MiFID I Implementing Directive

• Guidance under MiFID I:

– EC Commission Consultation Paper on the Review of MiFID - section 7.3.3 “Organisational requirements for the launch of products, operations and services”;

– ESA’s Joint Position on ‘Manufacturers’ Product Oversight and Governance Processes’ (November 2013);

– IOSCO (International Organisation of Securities Commissions) report ‘Regulation of retail structured products’ (December 2013); and

– ESMA opinion on ‘Structured Retail Products – Good practices for product governance arrangements’ (March 2014)


Level 1

8

Product governance: a new regime under MiFID II

• MiFID II introduces a completely new EU-wide product governance regime which applies to both sides of the product development and sales process, namely to (if different):

– product manufacturers: investment firms that create, develop, issue and/or design investment products, including investment firms advising corporate issuers on the launch of new securities; and

– product distributors: investment firms that offer and/or recommend investment products and services.

• The objective of the product governance requirements is to ensure that firms, which manufacture and distribute financial instruments and structured deposits, act in the clients’ best interests during all the stages of the life-cycle of products.


Level 1

9

Overview of the product life-cycle


Design & Governance

Target market

Marketing & Promotion

Sales and Advice

Processes

Post-Sales Handling

Design and governance

In summary, the important high level requirements for investment firms in terms of design and governance are:

– having organisational and administrative measures to prevent conflicts of interest arising with the products manufactured/distributed by those firms;

– ensuring that staff is adequately experienced / trained to manufacture products;

– ensuring management / governing body has effective control over the product governance process;

– including product governance in compliance reports;

– outlining mutual responsibilities in writing where use non-EEA Member State issuer to create/manage product; and

– stress testing the product under various market conditions to assess the risks of poor investor outcomes.


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling

Design and governance (cont.)

MiFID II: Product governance 12

Effective oversight

• Product governance committees

• Compliance is a standing member of the product governance committee

• There should be a link to the conflicts committee

Effective control

• Extent of market intelligence (data privacy issues)

• Senior management will have a responsibility in the whole process

Necessary experience of human resource in design process

• Training no longer an option – must have the necessary experience

• What about expertise with de novo / innovative products?

• Who are the relevant staff?

• What constitutes ‘necessary experience’?

• This is an on-going requirement

Design and governance(cont.)

MiFID II: Product governance 13

Scenario analysis – timeframe

• When do these analyses need to be conducted and when repeated?

• Part of product development process and review process?

• Part of stress testing

Scenario analysis – relevant scenarios

• Right kind of scenarios? Is there a link with the PRIIPs scenario testing, is that enough?

• Record-keeping and audit trail

• Provide outcome to distributors

Trigger for re-approval?

• When is a tweak a variation?

Target market

• It must be identified who the target market is and who it is not.

– Article 16(3) MiFID II: “The product approval process shall specify an identified target market of end clients within the relevant category of clients for each financial instrument and shall ensure that all relevant risks to such identified target market are assessed and that the intended distribution strategy is consistent with the identified target market.”

– Article 9(9) Delegated Directive C(2016) 2031: “Member States shall require investment firms to identify at a sufficiently granular level the potential target market for each financial instrument and specify the type(s) of client for whose needs, characteristics and objectives the financial instrument is compatible. As part of this process, the firm shall identify any group(s) of clients for whose needs, characteristics and objectives the financial instrument is not compatible. Where investment firms collaborate to manufacture a financial instrument, only one target market needs to be identified.”

• Bear in mind, MiFID II changing client categorisation:

– local authorities and municipalities no longer able to qualify as ECPs; and

– elective professional clients can no longer qualify as ECPs.


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling

Target market (cont.)

• ESMA’s consultation guidelines for manufacturers:

– The potential target market identification by manufacturers should not be solely conducted on the basis of quantitative criteria but needs to be based on sufficient qualitative considerations as well. List of categories (cumulative) provided in guidelines should be used to identify target market for products:

o type of clients to whom product is target;

o knowledge and experience;

o financial situation with a focus on ability to bear losses;

o risk tolerance and compatibility of the risk/reward profile of the product with the target market;

o clients’ objectives; and

o clients’ needs.

– Differentation on basis of the nature of the product manufactured, i.e. characteristics of product (including complexity, risk-reward profile, innovative character, etc.) to be considered.

– Articulation between the distribution strategy of the manufacturer and its definition of the target market.


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling


• ESMA’s consultation guidelines for distributors:

– Timing and relationship of target market assessment of the distributor with other product governance processes. Distributor’s target market identification should be part of general decision making process about the range of services and products the distributor is going to distribute. Target market identification should occur at an early stage, when the firm’s business policies and distribution strategies are defined by the management body (ex-ante and prior to going into daily business).

– Relation between the product governance requirements and the assessment of suitability or appropriateness.

– Distributors should use the same list of categories used by manufacturers as a basis for defining the target market for their products, however, distributors should do this on a more concrete level and should take into account:

o the type of clients they provide investment services to;

o the nature of the financial instrument; and

o the type of investment services they provide.

– Differentation on basis of the nature of the product manufactured, but also on the type of investment services that firms provide.

– Distributor to take the distribution strategy of the manufacturer into account and review it with a critical look.


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling


• Guidelines on issues applicable to both manufacturers and distributors:

– Identification of the ‘negative’ target market and sales outside the positive target market.

– Application of the target market requirements to firms dealing in wholesale markets (i.e. with professional clients and eligible counterparties).

• ‘Creation, development, issuance and/or design’

– EU: four types of manufacturers?

– Co-manufacturers

– Issues with conflicts of interests

– Agreeing a contract – what if they don’t agree?

– Client disclosures issues

– Link with PRIIPs

– In scope for one regime, in scope for the other


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling


• Sufficient provision of information to distributors and to clients

– Provision of adequate information to distributors so they can understand and sell properly.

– Challenge: What amounts to ‘adequate’? objective v subjective assessment, active v passive provision)

– Application of the target market requirements to firms dealing in wholesale markets (i.e. with professional clients and eligible counterparties).

– Challenge: ‘end’ client hook, how to know when the ECP is a manufacturer in themselves or a distributor? Contractual protection?

• Distribution network

– Know-Your-Distributor due diligence

– Written distribution agreement

– Consider restricting appointment of sub-distributors

– Ensure chain of liability matched

– Ensure suitability / appropriateness requirements on last distributor in chain

– Obligations to provide KIID (UCITS) / KID (PRIIPs)

– Ensure information flows up from distributor to manufacturer


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling


(cont.)

• When marketing and promoting products, inducement rules need to be taken into account:

– ban on receiving and retaining payments from third parties – these payments / benefits can be received but they must be passed on in full to clients as soon as possible following receipt;

– minor non-monetary benefits are excluded from the prohibition but they must not impair a firm’s duty to act in the best interests of its clients, must be capable of enhancing the quality of client service and must be disclosed (should be read strictly and interpreted narrowly) - EC to adopt an exhaustive list of what constitutes a minor non-monetary benefit to prevent regulatory arbitrage amongst Member States;

– clients need to be accurately and, where relevant, periodically informed about all the fees, commissions and benefits the firm has received in connection with the investment services provided; and

– where applicable, firms must inform clients on how the fee / commission / non-monetary benefit can be transferred to them


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling

Sales & Advice Processes

• Suitability or appropriateness

• Information to clients

• Record-keeping


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling

Suitability or

appropriateness


• Firms must obtain the following information from a client or a potential client

before providing the above services:

o its knowledge and experience of the investment field in which the investment

advice or portfolio management is to be offered;

o its financial situation including his ability to bear losses; and

o its investment objectives including the risk tolerance

• Obligation to take reasonable steps to ensure that investment advice and decisions

to trade (incl. to buy or to hold) are suitable

• Obligation also applicable to a package of services or bundled products and

structured deposits

• Firms must obtain information regarding clients’ experience and knowledge in order

to enable it to determine if the products and services envisaged are appropriate:

o the types of financial service, transaction and regulated financial instruments

the client is familiar with;

o the nature, volume and frequency of the client’s transactions in regulated

financial instruments; and

o the level of education, profession or former profession of the client

• Obligation also applicable to a package of services or bundled products and

structured deposits

• Firms may assume that the appropriateness test is satisfied if dealing with

professional clients, and not applicable to ECPs

21

Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling

Information to clients


• Information provided to clients should be:

– fair, clear and not misleading; and

– marketing communications must be clearly identifiable as such.

• Appropriate information in good time regarding:

– investment firm/services; and

– financial instruments/investment strategies/execution venues; and

– costs and related charges.

• Information provision must be:

– in comprehensible form; and

– in such manner that clients can make informed investment decision.

• The information may be standardised

22

Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling

Post-Sales Handling

• Firms are required to review products on a regular basis to assess whether the product remains consistent with the needs, characteristics and objectives of the identified target market and whether the intended distribution strategy remains appropriate. The same requirements apply to distributors in relation to services offered. More details in ESMA guidelines

• Product governance process in compliance reports to senior management means that sales information from distributors used to assist with review

• Complaints handling


Design & Governance

Target market


Sales and Advice

Processes

Post-Sales Handling

Questions

Disclaimer

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mifid ii academy: product governance - norton rose … ii academy - product governance ... •when...

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