Product design and governance: An opportunity presents itself

25 July 2016

By Andrea Wintermantel and Donna Riches

Whilst MiFID II has been delayed until 3 January 2018, firms cannot afford to relax when it comes to its regulatory requirements. In fact, we think that MiFID II’s Product Design and Governance requirements – which will require firms to monitor whether their products are sold to their intended target market – present a real opportunity for firms to improve their profitability.

There are practical reasons why it makes sense to think about MiFID II’s requirements on product design sooner rather than later. For one, there’s considerable overlap between these requirements and others, particularly the Packaged Retail Investment and Insurance-based Investment Products (PRIIPs) requirement to produce a Key Information Document, which is due to come into effect on 31 December 2016.

While PRIIPs is aimed at retail investors, the MiFID II requirements are more concerned with accountability through the supply chain and are based around the central concept that firms must design and sell products with a target market in mind.

The MiFID II requirements will result in a much heavier flow of information between manufacturers (firms that create, develop issue and/or design financial instruments) and distributors (those that offer to sell them); distributors will need to show manufacturers that they’re selling products in line with the intended target market.

It’s the latest in a line of regulation that encourage firms to look more closely at their distribution network and target markets. It means extra compliance work, of course, but we also think there’s a real opportunity here for firms to realign their existing products, think more strategically about how their products are sold, and identify new opportunities for products that investors want and need.

The end result could be a more profitable business. In some firms, the approach to distribution and product design has been too fragmented, resulting in too much concentration in some markets and not enough in others, and in products that aren’t closely matched to investors’ needs.

While close monitoring of the target market will be a new concept for firms, there should be frameworks already in place from which they can draw information. For example, approval processes for large trades, new business approval processes and allocation committees for new issues should already be looking at the purpose of the product and to whom it is sold.

So what should firms be doing to prepare? We’ve identified four stages:

  • Identify the target market. Develop a product taxonomy and a matrix to record the target market. Implement triggers for when each product should be reviewed.
  • Identify the manufacturer and distributor for each product class and update distributor agreements.
  • Think about whether approval committees and procedures need to be updated.
  • Since regulators will have the power under MiFID II to ban a product, firms should prepare a documented approach detailing how they intend to react if this happens: Who will be involved? Which systems will be affected? What will you say to clients?

Member States will have some discretion in how to implement the final requirements, which could make things more complicated for international firms. But that doesn’t mean that delaying work on these requirements will be helpful – get prepared, and get ahead.

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