16 February 2017

MIFID II is effective from 03 January 2018. The FCA’s consultation (which closed on 04 January 2017) sets out the FCA’s proposals for the implementation of the MIFID II provisions on product governance. The FCA expects to publish its feedback and final rules in the first half of 2017.

This article explains the MIFID II requirements on product governance, the FCA's implementation proposals, our thoughts on the practical implications for fund managers (i.e. manufacturers) and distributors and some of the issues that firms should be thinking about ahead of the implementation.

What are the MIFID II provisions on product governance?

The FCA’s CP 16/29 consultation states that “product governance” means, in essence, the creation and management of products throughout their life cycle.

The proposals are relevant for both manufacturers and distributors.

A manufacturer is described as “a firm which creates, develops, issues, and/or designs investments, including when advising corporate issuers on the launch of new investments” and a distributor is an “investment firm that offers, recommends or sells investment products or provides investment services to clients.”

The FCA’s consultation states that, under the MIFID II requirements, firms are required to:

  • assess the target market and risks for new products (or product re‑issues) that the firm manufactures or distributes
  • ensure board level accountability for the process
  • ensure compliance oversight of the process
  • employ staff with relevant competence for these roles
  • choose appropriate distribution channels
  • monitor existing products on an ongoing basis to check they function as expected, are sold to the expected target market and remain consistent with the needs of the target market
  • take action if they identify any problems.

The FCA’s implementation proposal: rules or guidance?

The FCA’s proposal is to implement product governance provisions in MIFID II as rules for firms engaged in MIFID business and as guidance for non‑MIFID firms which manufacture or distribute MIFID products. Where appropriate, the FCA proposes to copy out the existing guidance such as from the RPPD (The Responsibilities of Providers and Distributors for the Fair Treatment of Customers) into the rules to explain certain concepts.

The new rules and guidance will replace broadly equivalent existing guidance in the RPPD, so for firms that are in compliance with or are familiar with the existing guidance, this should not represent a huge change, although certain aspects go beyond the RPPD.

What are the obligations for manufacturers?

  • Product design, including product charges, should meet the needs of the target market and the firm should identify groups for whom the product is unlikely to be suitable.
  • Firms should consider the impact of new products on the orderly functioning of the market.
  • Products should be stress tested.
  • The charging structure should be assessed to ensure it is appropriate.
  • The distribution strategy should meet the needs of the target market.
  • Firms working together to develop a single product should have a written agreement setting out their share of these responsibilities.
  • The compliance function at the firm should monitor product governance and firm management Boards should have effective control and oversight over the process.
  • Firms should provide relevant information to distributors.

What are the obligations for distributors?

  • Before distributing a product, firms should consider for which target market it is likely to be suitable and any groups for whom it is unlikely to be suitable.
  • Firms should gather the relevant information from manufacturers.
  • The distribution strategy should meet the needs of the target market.
  • Products should be reviewed regularly to confirm they remain consistent with the target market’s needs and make changes to the distribution strategy or other processes if they identify problems.
  • Firms should provide product manufacturers with information on sales and, where appropriate, the regular reviews mentioned above.
  • The firm’s compliance function should monitor product governance.
  • Firms’ management Boards should have effective control and oversight over the process.
  • Firms working together to distribute a single product should share information with other firms in the chain.

What is the likely impact on UCITS Management Companies and AIFMs?

Much will depend on a firm’s business model and the distribution model used to sell funds. For example, some firms have an integrated model whereby the management company and the distributor(s) are part of the same group; others appoint third party distributors instead. Some UCITS Management Companies (ManCos) or AIFMs are also MIFID firms, while others are not.

UCITS ManCos and AIFMs are generally exempt from MIFID. For a UCITS ManCo or AIFM that is a manufacturer but is not involved in MIFID business, the product governance provisions will apply as guidance and not as rules. These will be found in a new sourcebook for Product Governance and Intervention which will be known as “PROD”.

What are some of the key issues?

1. Target market identification

A manufacturer must design products that meet the needs of the target market. This might be an issue for a UCITS ManCo or AIFM as the identity of the end client is not always clear, especially for firms with multiple business models and/or distribution models through which a fund could be sold.

For example, the proposed provision in the new PROD 3.2.8 states that the target market needs to be identified at a “sufficiently granular level”. This is far from clear. What exactly are the target investors’ “needs”? Will there be any further regulatory guidance on this? How easy or difficult is it to identify the underlying target market, for example for funds sold via multiple platforms or multiple distribution channels?

Another potentially tricky issue is that a firm is required to identify any group or groups of clients for whom the financial instrument is not suitable (in terms of the needs of the client, or the characteristics or objectives of the financial instrument – for example, units in a fund).

Firms will need to identify, up front where relevant, that the product is suitable for X clients but not for Y clients. As a corollary to this, one might expect the FCA to require that this distinction is reflected in investor disclosures – in the prospectus for example – so firms will need to identify this and think about how they describe it. Of course these types of distinctions may not always be straightforward.

2. Distributor liaison/oversight

A manufacturer is required to define a distribution strategy so that the product is sold to the identified target market. The manufacturer must make available to distributors all appropriate information on the product and the product approval process and information about the appropriate channels for the distribution of the product.

3. Product review

Once a product has been launched, manufacturers will still have regularly to review it (the frequency would be based on relevant factors linked to the complexity of the product) and take into account any event that could materially affect the potential risk to the identified target market.

They will have to assess the following:

  • Is it still consistent with the needs, characteristics and objectives of the identified target market?
  • Is the intended distribution strategy still appropriate?
  • Is it being sold to the target market?
  • Is it being sold to those for whom it is not suitable?
  • Does it function as intended?

They will also need to collect and analyse Management Information (MI) to detect patterns in distribution as compared to the planned target market. This might be especially difficult where the product is sold through multiple and/or varied channels.

4. Conflicts of interest and oversight

A firm is required to have processes to manage, analyse and assess this, including as to remuneration. The management body is required to have effective control over the product governance process - overseen by Compliance; and staff involved in product manufacturing need the relevant expertise to understand the characteristics and risks of the products they intend to create.

5. Compliance reports

Compliance reports to the management body must include information about products that the firm has manufactured and the distribution strategy. The report must be available to the FCA on request. It is not immediately clear how frequently these reports should be prepared - or whether these will just need to be included as part of the usual reporting cycle, for example at quarterly board meetings.

What should firms be thinking about?

Firms should look at the existing guidance (such as the RPPD) and undertake a gap analysis against the MIFID II provisions. As mentioned above, the MIFID provisions should not represent or require a significant change for those firms already complying with the existing guidance. Some of the questions that firms should ask themselves include:

Product approval

  • Do products undergo an appropriate approval process? Do you need to make any improvements to that process?
  • Do you need to look at the make-up of your product design staff and your products approval committee(s)?
  • Does the board sign off on new products or changes to products?
  • Is there a coherent distribution strategy? Does this form part of the product approval process, as it should?

Target market identification

  • Do you know who your end investors are?
  • Can you demonstrate how you identified them?
  • Do you know what their “needs” are?
  • If challenged to demonstrate that investors “need” the product, can you do so (with evidence – e.g. in-depth research)?
  • Are you making available to investors products that you have identified that they need (good practice), or are you simply creating a product and then hoping to persuade investors to buy it (poor practice)?
  • What happens if your target market changes? Do you monitor external factors that might change the definition of your target market (as opposed to you consciously changing the target market)? What do you need to do if this happens?

Stress testing

  • Are your products robust (from a stress testing perspective)? Can you readily demonstrate/evidence this?
  • Have you thought about all the risks posed by the product?
  • How do these risks fit with your identified target market and the needs of that target market? What happens if these no longer fit?
  • Are the risks adequately disclosed to investors?

Charging structure

  • Is the charging structure fair?
  • How does the charging structure compare to similar products distributed to similar target markets?
  • Is the charging structure clear to investors?

Manufacturer/distributor liaison

  • Are you clear on your distribution chain – do you know who is distributing your product?
  • What data do you need to collect (in order to provide this to your distributor)? Do you have the required data collection capability and can you meaningfully interpret it - or do you need to appoint and work with an external data services provider?
  • Do you have the resources and tools to monitor and report on the distribution channels going forward? Do you need to do this more frequently or more rigorously?
  • How well do the distributors know the product? Do you need to educate them about the features of the product - and if so what is the most effective way of doing this?


  • Do you need to revisit your distribution agreements?

A word on proportionality

The FCA states in paragraph 13.18 of CP 16/29 that it expects the provisions to apply in an appropriate and proportionate way, taking into account the nature of the investment product, the investment service and the target market of the product. What this means in practice will of course depend on each firm and each product.

The FCA goes on to say that this approach takes forward the FCA’s existing approach and the FCA therefore expects the introduction of the new provisions to be an evolution of existing standards rather than requiring significant change. Watch this space!

How can Burges Salmon help?

We can advise on all aspects of product manufacture and distribution, including: structuring, fund formation, ongoing management of funds, distribution arrangements (including platform arrangements), fund documentation, agreements and regulatory issues. If you have any queries or require further assistance, please contact Tom Dunn.

Key contact

Tom Dunn

Tom Dunn Partner

  • Head of Regulated Funds and Financial Services
  • Regulated Funds
  • Financial Services

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