Member Article

European Securities and Markets Authority (ESMA) published its final report on “guidelines of MiFID II product governance requirements” yesterday.

I cannot do better than highlight the first paragraph of the Executive Summary to identify the direction of travel ESMA is taking: it ends by saying (with my added emphasis) “The MiFID II product governance requirements should therefore ensure that firms act in their clients’ best interests during all stages of the product’s life cycle”. Annex V contains the detailed guidelines.

Note that the guidelines themselves are not binding in the same way as the FCA’s consumer duty rules.

The guidelines cover both manufacturers and distributors.

Manufacturers “should” use the following five categories when designing and manufacturing products:

1. The type of clients to whom the produce is targeted;
2. Target clients’ knowledge and experience;
3. Target clients’ financial situation with a focus on the ability to bear losses;
4. Risk tolerance and compatibility of the risk/reward profile of the product with the target market;
5. Target clients’ objectives and needs.

Distributors must undertake a separate target market identification – using the same five categories as manufacturers but more “targeted” as the distributor should have specific clients (or categories of client) in mind – as well as an assessment of suitability and appropriateness. ESMA believes that the distributor’s “management body” is responsible for the target market identification. The management body’s responsibility is to ensure that “client-facing employees are informed of the approach… so that they can comply with it”.

There are some distinct similarities with the FCA’s Consumer Duty and some marked differences.

• ESMA acknowledges that a distributor’s obligations are dependent on the financial service it is offering to its target client (in other words, there is an explicit distinction between “advised” and “non-advised”/”execution-only” services). This is a distinction which implicitly is missing in the FCA’s Consumer Duty.
• ESMA requires both manufacturers and distributors to “review products on a regular basis to assess whether the product remains consistent with the needs, characteristics and objectives” of the target market and whether the “intended distribution strategy remains appropriate”. This is in marked contrast to the FCA’s approach: the FCA leaves the distributor and manufacturer to determine individually the impact of the Consumer Duty on their respective roles – by reference to their ability to impact direct consumer outcomes; and the FCA states (nonsensically in my view) that each firm in the distribution chain is responsible only for its own role and no others’;
• I say “nonsensically” because in practice the FCA’s approach cannot be correct – if we assume the following is correct:
  • the FCA does not believe that there is any such thing as pure “execution-only” services;
  • the FCA believes that every firm in a distribution chain can impact consumer outcomes,

then it must be correct that the FCA would expect a distributor or adviser either (a) to cease to distribute or advise products or services about which it is not happy its own supplier can ensure meets its obligations or (b) to require its own supplier to amend the product or service being distributed.

• Please do not misunderstand me: just because I believe that the FCA’s stated position is different from ESMA’s and nonsensical, I believe also that the FCA’s expectations are the same as ESMA’s and that will be the outcome.
• one consideration expected by the FCA which is missing from ESMA’s guidelines is the “behavioural” – yes, ESMA does discuss that firms need to take into account clients’ likely behaviour. But in the context of how the product or service is marketed (e.g. ESMA does not like “gamification”) rather than the much broader FCA approach that firms should consider the distinct possibility that every potential client is lying to his/her/itself about whether the product is suitable or appropriate.
• ESMA’s approach to management responsibility and culpability differs also from the FCA’s: there is no “champion” of the consumer for ESMA; but there is a “culture tone from the top”.

In short, once again (as with Payment for Order Flow and SMCR), where the FCA leads it appears ESMA may follow. Hopefully, the differences in guidance will be instructive and permit firms to establish processes which comply with both EU and UK rules and be helpful to firms which are branches of (or whose headquarters are) EU firms.

 

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