19 October 2017


Earlier this year we reported on the FCA's consultation on its proposed implementation of the MiFID II provisions on product governance. In our article, we looked ahead at how the FCA’s proposed implementation of these product governance requirements (found within a new ‘PROD’ sourcebook) might impact UCITS Management Companies and AIFMs.

Following the FCA’s publication of its second policy statement and finalised PROD Handbook as well as the release of ESMA’s final report on product governance, this article considers more specifically the obligations of manufacturers and distributors in relation to the identification of the target market for products (i.e. financial instruments such as units/shares in a FCA authorised fund).

Recap: What are the MiFID II product governance provisions?

The purpose of the product governance provisions (as implemented in PROD) is to improve firms’ product oversight and governance processes. This means the systems and controls firms have in place to design, approve, market and manage products throughout the product's life to ensure they meet legal and regulatory requirements. Good product governance should result in products that:

  • meet the needs of one or more identified target markets
  • are sold to clients in the target markets by appropriate distribution channels
  • deliver appropriate client outcomes.

The product governance obligations for manufacturers are found in PROD 3.2.1, which states that a manufacturer must:

  1. ensure that their products are designed to meet the needs of an identified target market within the relevant category of clients (i.e. retail and professional clients and eligible counterparties)
  2. ensure that the strategy for distribution of the product is compatible with the identified target market
  3. take reasonable steps to ensure that the product is distributed to the target market.

The product governance obligations for distributors (under PROD 3.3.1) state that a distributor must:

  1. understand the products it is distributing to clients
  2. assess the compatibility of the products with the needs of the clients to whom it distributes (taking into account the manufacturer's identified target market)
  3. ensure that the products are distributed only when it is in the best interest of the clients.

Target market identification: what are product manufacturers’ and distributors’ obligations?


Under PROD, manufacturers are required to identify the target market for each product at a "sufficiently granular level". In our last article, we commented that there was a lack of clarity as to how the FCA expected firms to meet this requirement.

It is stated that the manufacturer must:

  1. specify the type or types of client for whose needs, characteristics and objectives the product is compatible
  2. identify any group or groups of client for whose needs characteristics and objectives the product is not compatible.

The level of granularity of the target market and the criteria used to define the target market should be relevant to the product and should make it possible to assess which clients fall within the target market.

So, for example, for a straightforward UK equities UCITS, the target market could potentially be identified with less detail than for more complicated instruments such as a bail-in instrument. PROD states that this must include an examination of:

  1. whether the product's risk/reward profile is consistent with the target market
  2. whether the design of the product is driven by features that benefit the client and not by a business model which relies on poor client outcomes to be profitable.

PROD also recognises that manufacturers who distribute products through other firms may not have a direct relationship with the end client or first-hand information in order to evaluate the clients' needs and characteristics. So, manufacturers must assess the target market based on their 'theoretical knowledge' and past experience of the product or similar products, financial markets, and the needs, characteristics and objectives of potential end clients.


Distributors, on the other hand, will often have direct contact with the investors who purchase the products. However, it is clear that firms who are 'distributors to distributors' also fall within the PROD requirements, seemingly with a view to ensuring an unbroken 'chain' from manufacturer through to end investors.

Distributors must determine the target market for the product even if the target market was not defined by the manufacturer. Therefore, distributors are expected to identify the target market using information provided to them by the manufacturer – and their own information on the end-investors.

In identifying the target market and creating a distribution strategy, distributors should consider the following criteria:

  1. The nature of the product to be offered and how that fits with the end client’s needs and risk appetite.
  2. The impact of the charges on the end client.
  3. The financial strength of the manufacturer.
  4. Where information is available, how efficiently and reliably the manufacturer will deal with the end client (such as in relation to complaints, or when the product reaches maturity, if applicable).

Like manufacturers, distributors are also required to identify the target market at a sufficiently granular level, and appropriately to identify any groups of end investors for whose needs, characteristics and objectives the product is not compatible.

ESMA guidelines on the identification of the target market

ESMA’s final report on product governance seeks to give additional clarity for firms looking to identify the target market for products. In particular, ESMA suggests five categories for manufacturers and distributors to use as a basis for identifying the target market for the product. The list is not intended to be exhaustive and the categories may be weighted by firms according to their relevance to the products (although no categories should be excluded outright). The categories are:

  1. The type of clients to whom the product is targeted – this should be assessed according to the MiFID II client categorisation (retail client, professional client and eligible counterparty).
  2. Knowledge and experience – the firm should specify how much knowledge and experience the target client should have about certain elements of the product.
  3. Financial situation with a focus on the ability to bear losses – the firm should specify the percentage of losses the target clients would be able and willing to afford and any additional payments they would be prepared to make.
  4. Risk tolerance and compatibility of the risk/reward profile of the product with the target market – the firm should specify the target clients’ attitude to risk based on different categories of risk with clear criteria for each category. Firms should use the risk indicator in the PRIIPS KID or UCITS KIID where applicable to fulfil this requirement.
  5. Client’s objectives and needs – the firm should specify the investment objectives and needs of their target clients, such as the wider financial goals and overall strategy for making investments.

ESMA’s final report confirms that distributors are expected to make a more thorough analysis of the characteristics of their client base in order to specify the actual target market (as compared to the manufacturer's obligation to conduct a more general review in order to specify the potential target market based on its theoretical knowledge and experience of similar products).

10 questions to consider

The key to meeting the new product governance requirements will be for increased dialogue between manufacturers and distributors. This should be done at the earliest possible stage of a product's development so that the manufacturer’s (or co-manufacturer’s) knowledge of its products is supplemented with the distributors’ knowledge of their clients.

With distributors having separate product governance obligations from manufacturers, based on separate criteria and informed by different sources of information, there is a risk that, without prior or proper consultation, distributors might identify a different target market from the manufacturer (leading to possible mis-selling, for example).

Some of the questions which manufacturers and distributors should consider when identifying the needs, characteristics and objectives of their target clients are:

  1. Who are your end clients?
  2. How long do your clients plan to make their investment?
  3. What MiFID II client category are they?
  4. How much knowledge should these clients have of that particular type of product and its features?
  5. How much experience should these clients have of that type of product? How long should they have been active in the market?
  6. What percentage of loss would the client be willing and able to afford?
  7. Would the client be willing to accept additional payment obligations exceeding the amount of the investment?
  8. What is the client’s risk appetite?
  9. What are the client's financial goals? Do they have an investment strategy?
  10. Are there any external factors which could lead to a change in your target market?

Manufacturers and distributors will need to communicate on changes in the market and the needs of their clients and re-evaluate their assessment of the target market.

With 3 January 2018 fast approaching, manufacturers and distributors should be collaborating and agreeing their mutual responsibilities around target market identification and product governance processes with regard to the manufacture and distribution both of new and existing products. 

How can Burges Salmon help?

Our investment funds and financial regulation team has vast experience in dealing with a wide range of fund-related matters. If you would like to discuss any of the points raised in this feature or any funds-related matters 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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