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What has happened?

The FCA’s MiFID II product governance review, the findings from which were published in February 2021, looked at product governance in a sample of eight asset management firms. It examined how these firms, as product providers (manufacturers), take MiFID II’s product governance rules into account throughout the product lifecycle.

The FCA visited a small sample of eight asset managers/manufacturers with group assets under management ranging from £2bn to over £100bn and selected a ‘case study’ product for each firm; either one launched after January 2018 or, if launched before this date, one that had subsequently made significant changes. All the products assessed were UK authorised collective investment schemes available to retail investors through platforms on both an advised and an execution-only basis. The funds reviewed apply a range of strategies covering equity, derivative and fixed income assets with a total value of around £7bn.

The findings were evaluated against the relevant requirements and guidance in the FCA Handbook.

What do you need to do?

The review suggests that some asset managers are not undertaking activities in line with MiFID II’s PROD regime and the FCA believes there is significant scope for asset managers to improve their product governance arrangements.

The reliance on intermediated services in the UK investment market means that manufacturers commonly rely on the distributors of their products to give them relevant information on the end consumer. The review found that distributors rarely pass this information on to asset managers, which hinders firms’ ability to effectively meet best practice on product governance. Asset managers and product distributors need to prioritise effective cooperation and information sharing to address the potential harm to consumers from poor product design and distribution processes.

The FCA grouped its key observations into four main areas: product design, product testing, distributors and governance & oversight.

Product design

The observations made here focused on how well firms assess the negative target market and conflicts of interest.

Negative target market

Of the firms in the review, only one manufacturer appeared to have considered the ‘negative target market’ concept, but it could not identify the specific group of consumers that would be a 'negative target market’ for its products. One firm reviewed had a negative target market that overlapped with an existing investor-base. In this case, the negative target market was defined as investors who wished to hold the investment for longer than five years, yet the firm recognised that some investors could remain invested beyond that timeframe.

PROD asks asset managers to identify the potential target market for each financial instrument and specify the type of clients the product is compatible with, or not (a negative target market). Firms should also determine whether the risk/reward profile is consistent with the target market.

Conflicts of interest

All firms in the sample had a framework for managing conflicts of interest, but not all of them appeared to be effective.

The FCA expects firms to identify, manage and mitigate potential conflicts while providing a service. They should consider whether there are certain product characteristics, such as charges, objectives or its general operation, that could benefit the firm at the expense of the end investor. They should also consider whether there are conflicts that may create incentives to favour one set of investors over another. It is important to manage any potential conflicts in such cases while considering information involving the target market and distribution strategy.

Product testing

The observations here focused on scenario and stress testing, as well as how the firms disclosed costs.

Scenario and stress testing

While all manufacturers could provide evidence of some scenario and stress testing, their approaches varied. Differences included how far their analysis considered product-specific characteristics such as underlying assets, investor bases and concentration in times of market volatility and stress, the product’s commercial viability and how far they relied on backwards-looking scenarios rather than more recent developments.

Costs disclosures

Firms need to improve their costs and charges disclosures, since some cost information shown in marketing documents did not match the information shown in regulatory documents such as the UCITS Key Investor Information Document.

Most of the firms assessed also appeared to leave out certain charges, particularly portfolio transaction costs, from their cost disclosures. The FCA expects manufacturers to disclose costs and charges in a way that is clear, fair and not misleading and that complies with relevant regulatory requirements.

Distributors

The observations here focus around firms’ due diligence, the information they sought from distributors and their use of management information.

Due diligence

The quality of due diligence over distributors was variable, with some firms assessing their distributor’s arrangements more robustly than others.

Information from distributors

All asset managers faced challenges in getting end-client data from distributors - even when they specifically asked for this information. Some asked for feedback through meetings rather than with detailed questionnaires. A recurrent theme was that asset managers feel unable to influence distributors because of the commercial sensitivity of the data request.

The FCA’s view is that asset managers could do more to challenge their distributors for this information - and document that challenge - to work towards a more collaborative relationship that allows asset managers to meet their obligations to act in clients’ best interests.

Management information

The systems and procedures for monitoring data internally varied, as did how firms use management information.

The FCA published ‘Treating customers fairly – guide to management information’ in 2015 and this remains relevant in giving examples of good and poor practice and helping firms develop MI. Given the challenges asset managers face in getting information from their distributors, they should consider this guide and how they can improve their MI to help identify and monitor key trends that may lead to emerging risks.

Governance & oversight

Nearly all firms reviewed carried out a formal product assessment or review every year. However, different firms showed varying levels of oversight and challenge across these governance channels. Key areas focused on was the second line of defence and product governance committees, the obligations of the authorised fund manager board, how firms approached record keeping and training on product governance.

Second line of defence and committees

All asset managers had product governance committees, but some fell short of the FCA’s expectations. The role of the second line of defence was often poorly defined, meaning that the potential for meaningful challenge was limited.

Authorised Fund Manager (AFM) Board

While firms were aware of the AFM Board’s product governance obligations and the need for oversight of the relevant committees’ work or their second-line functions, there was variation in the quality of contribution from the independent Non-Executive Directors

Record keeping

Most asset managers had poor record-keeping. Where firms did not document challenge, decisions and checks, they were unable to recall what activities had taken place.

Training

While relevant training is generally in place, the quality and focus areas of this training varied and it did not always include the importance of the needs of and outcomes for the end investor.

Following these observations, the FCA is likely to undertake further work on this subject. Part of this may involve considering whether it needs to make further changes to its product governance rules and guidance for both asset managers/manufacturers and distributors.

`If you’d like to know more about how we can help you with your product governance, due diligence or oversight arrangements, or with any other aspect of compliance, our expert team is here to help. Contact us today on 0207 436 0630 – or email info@thistleinitiatives.co.uk.