On 26 February 2021, the FCA issued the results of a review of product governance in a sample of 8 asset management firms. The review examined how these firms, as product providers, take MiFID II’s product governance rules into account, particularly the interests of the end clients, throughout the product lifecycle.
The review found that some asset managers are not undertaking activities in line with MiFID II’s product governance regime (PROD).
Key findings include:
- Of the firms in the review, only 1 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 UCITS and non-UCITS retail scheme products. 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 as outlined in PROD 3.2.10R. The FCA expects asset managers to carry out these activities to enable them to comply with the customer best interest rules (COBS 2.1.1R or COBS 2.1.4R and PRIN 6).
- All firms in the sample had a framework for managing conflicts of interest, but not all appeared to be effective. Simply having a framework in place is not enough; the ultimate outcomes are fundamental. Failing to undertake these activities may damage the interests of a client and also risks breaching rules in SYSC 10 and PRIN 8 (conflicts of interest).
- While all manufacturers could provide evidence of some scenario and stress testing, their approaches varied. To protect investors, PROD asks certain firms to carry out scenario analysis to assess the risk of poor outcomes to consumers and the circumstances in which they may occur. This includes assessing resilience in volatile market conditions and scenarios that may affect how an individual product performs (outlined in PROD 3.2.13R). Stress tests should cover adverse market conditions, including the firm’s own financial strength, asset-specific stresses and any risks from a highly concentrated consumer base. The FCA expects firms to consider such activities in order to comply with other rules, such as BIPRU 12.4.1R, COLL 6.12 or FUND 3.7.
- There are areas where firms need to improve their costs and charges disclosures. 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 the FCA 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.
- The quality of due diligence over distributors was variable. Some firms assessed a distributor’s arrangements more robustly than others. Due diligence means asset managers can establish whether their chosen distributors are fit for purpose in client on boarding and if a distributor’s intended product recipient matches the product’s target market.
- 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. It appears to the FCA that commercial agreements and sensitivities between asset manager/product provider and distributor may be taking precedence as asset managers are reluctant to insist on end-client data trends from their distributors. The FCA feels 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.
- The systems and procedures for monitoring data internally varied, as did how firms use management information (MI). The FCA published ‘Treating customers fairly – guide to management information’ in 2015. It remains relevant in giving examples of good and poor practice and helping firms develop MI.
- Nearly all firms 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 the FCA focused on were 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.
- Most asset managers had poor record keeping. This may have been due to a lack of formal process in product design and oversight. The inability to evidence robust challenge and oversight should raise concern for those individuals accountable for this activity (the focus of the new Senior Management and Certification Regime) as it leaves firms and those accountable unable to evidence challenge and oversight, potentially in breach of SYSC 9.1.1R.
The FCA states that it’s likely it will undertake further work in this area. Part of this may be to consider whether it needs to make further changes to its product governance rules and guidance for both asset managers/manufacturers and distributors. The regulator will also consider whether these changes will better address the key sources of harm throughout the product lifecycle.
The FCA expects firms to ensure their activities prioritise good customer outcomes and that they comply with the relevant regulatory rules and requirements. Where the FCA identifies potential breaches of its rules, it will consider whether it needs to take action, which may include opening investigations or other appropriate measures.