Article:

MiFID II Product Governance: FCA finds room for improvement following review of asset management firms

09 March 2021

In February 2021, the FCA published the findings of its review of the product governance arrangements within a sample of eight asset management firms. As anticipated, the review identified instances of non-compliance with the requirements and the overall conclusion was that there is significant scope for firms to improve their product governance arrangements.

The review examined the lifecycle of a ‘case study’ product for each firm. The FCA’s review focused on asset managers offering UK-authorised collective investment schemes available to retail investors through platforms both on an advised and execution-only basis. This is a broad and potentially sensitive investor population and the regulations should be diligently applied to ensure both manufacturers and distributors act in best interests of end-investors. The product governance rules do include a proportionality principle however, and firms catering exclusively to a wholesale market should consider how the findings of the FCA’s review may apply to them in the context of their adapted product governance framework.

The FCA’s observations are categorised into four key areas – product design, product testing, distributors and governance and oversight.

  • Product Design: The majority of firms in the sample had not considered and identified a product’s ‘negative target market’. Firms should ensure that they specify the types of client a product is compatible with as well as specifying the clients for whom it is not suitable. Firms should also determine whether the risk/reward profile for a financial instrument is consistent with the target market identified.
    While the review found that all the sampled firms had a framework for managing conflicts of interest in place, these were not always effective. Consideration of potential conflicts should be made at the product level – firms should consider whether the products characteristics including charges, objectives or general operation, could benefit the firm above the investor.
     
  • Product Testing: The FCA notes a varied approach to scenario analysis and stress testing, although all firms in the sample do undertake some form of testing. It highlighted the requirement to assess product performance in adverse market conditions.
    The review found ongoing failures with respect to costs and charges disclosures. The FCA observes that in some cases information on costs set out in marketing materials did not align with the information in the KIID. The regulator reminds firms to ensure all costs are appropriately and consistently disclosed, including portfolio transaction costs.
     
  • Distributors: The review found that firms were not consistently undertaking thorough due diligence on distributors to establish whether they are fit for purpose and appropriate for the product’s intended investor population. The FCA notes that some firms see limited value in undertaking due diligence over distributors. All firms in the sample reported ongoing difficulties gathering information from distributors. The FCA believes asset managers could do more to challenge distributors for this information and that any such challenge should be recorded. Finally, the FCA found a variety of approaches to MI in the review and points firms to the ongoing relevance of its 2015 publication Treating Customers Fairly – Guide to Management Information for examples of good and poor practice.
     
  • Governance and Oversight:  While all firms in the sample had committees and compliance resource dedicated to product governance some were poorly defined and ill-equipped to provide effective challenge. The FCA reminds firms of the importance of keeping accurate and detailed records to capture challenges and the rationale for decisions taken. This is particularly important in the context of Senior Manager responsibilities. Finally, training should be focused and responsive to ensure staff remain sufficiently knowledgeable and competent to develop and oversee products. 

The FCA has indicated that it will likely undertake further work on this subject, given the findings of this limited review. The regulator acknowledges that PROD applies as guidance rather than binding rules for some authorised fund managers and that AIFMD and UCITS require these firms to act in the best interests of their investors. However, the FCA suggests that the product governance requirements can provide a detailed framework to ensure that that these obligations are met.

It’s clear that this will continue to be an area of focus for the regulator for some time. These requirements have been in force since January 2018 and the FCA will expect to see lessons learned in that time and applied to improve the efficacy of the frameworks. The FCA have stated that they expect firms to ensure their activities promote good customer outcomes.

Over the last few years, BDO has supported a broad range of both manufacturers and distributors in developing and testing their product governance frameworks. If your firm needs support in ensuring your framework is dynamic and effective, please do contact us.