In January 2018, MIFID II introduced the product governance regime (PROD) for firms that design and distribute financial instruments. The new regime drew heavily on the FCA’s RPPD guidance, “The Responsibilities of Providers and Distributors for the Fair Treatment of Customers”, aimed at all regulated firms who provide products and services to retail clients. Both still co-exist in the regulatory ether. PROD, though, seems to be emerging as more dominant of the two, because, as rules, PROD provides a framework for what firms must do, rather than guidance on what firms should do.
With unusually low-key fanfare, the FCA has published its findings of a multi-firm review based on a small sample of UK-authorised collective investment scheme asset management firms, with group assets under management ranging from £2bn to over £100bn. The review focused on product providers (manufacturers) and examined how they take PROD into account, and particularly the interests of the end clients, throughout the product lifecycle.
The FCA has published the detail findings here. Our summary below highlights some relatively unsurprising problems the FCA found to support their conclusion that there is significant scope for asset managers to improve their product governance arrangements.
FCA found both insufficient consideration and overlapping of products’ negative target market definitions. Combined with ineffective conflicts of interest arrangements, the FCA calls for better identification as to whether a product benefits the firm rather than the investor as a result of fund charges, objectives or its general operation.
FCA found that manufacturers approach to scenario and stress testing varied. FCA reminds firms that scenario analysis should include assessing resilience in volatile market conditions and scenarios that may affect how an individual product performs. Stress tests should cover adverse market conditions, including the firm’s own financial strength, asset-specific stresses and risks from a highly concentrated consumer base.
Firms need to improve the consistency of their disclosures across marketing and regulatory documents such as the UCITS Key Investor Information Document. Previously raised as a concern in another FCA multi-firm review (February 2019), it appears that firms are still not getting this right, with firms omitting portfolio transaction costs from their cost disclosures.
The quality of due diligence over distributors was variable, some asset managers thought it added little value. The FCA thinks otherwise: due diligence means asset managers can establish whether distributors are fit for purpose in client onboarding and that the product is reaching its intended target market.
PROD requires information exchange between manufacturers and distributors. The FCA noted that this is not happening, with commercial arrangements cited as a hindrance, perhaps due to the dominance of some distributor platforms, perhaps reflecting a disinclination of asset managers to insist on end-client data trends from their distributors.
Governance & Oversight
The FCA identifies a number of governance improvements asset managers may want to consider:
The FCA’s assessment is there is significant scope for improvement to be made. The FCA will continue to focus on product governance, considering the value of further changes to PROD rules and guidance. It threatens to open investigations “or other appropriate measures” where it identifies potential breaches of its rules.
Ellis Wilson – What should managers do?
Don’t take false comfort from the FCA’s limited scope of reviewing some of the largest asset managers, those who are most likely to have, and have committed, the resources to deliver structured product governance arrangements. If the FCA has found fault here, then smaller asset managers should consider how their arrangements will pass FCA scrutiny. This should be relevant to those who have been charged with individual accountability for Product Governance under SMCR.
Nor should comfort be drawn from the FCA’s focus on UK authorised funds. Product Governance arrangements apply to the manufacture of Financial Instruments generally, around product design, product testing, distribution and governance and oversight. Managers should consider the effectiveness of their Product Governance arrangements across their product range, particularly with respect to higher risk products that should not be distributed on a mass-market basis.
In these ways, firms will more likely meet the FCA’s principal expectation, that manufacturers act in the best interests of the funds they manage and of those who invest in those funds.
For more information on PROD compliance contact Ellis Wilson.
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