Product Governance and Investor Protection

The answer from MiFID II is not what we thought

ATTILIO VENEZIANO, VENEZIANO & PARTNERS LTD

MiFID II is looming and the entire industry is still grappling with some of the additional obligations – some of them unusually burdensome and costly to implement – the recast directive will impose on market participants.

In particular, MiFID II introduced a new set of product governance rules designed to increase the level of investor protection. As stated in the ESMA Consultation Paper on Draft Guidelines on MiFID II product governance requirements, these new rules aim at ensuring that product manufacturers of financial instruments and structured deposits, as well as distributors, have at all times the best interests of the investors in mind. The new product governance requirements under MiFID II are introduced having in mind the best interests of investors. When it comes to presenting a client with an investment product or solution, according to the new rules this will have to be perfectly suitable for their best needs and interests, which should at all times prevail over commercial or funding needs of investment firms.

Whilst the importance of clients’ best interests – boldly emphasized throughout MiFID II both in the first level directive as well as secondary level delegated directive – is not necessarily new, the approach now adopted in the European legislation on financial services with regards to investor protection appears to be innovative, at least at a first glance. It was felt – as also stressed in the Draft Guidelines – that the mere existence of conduct of business rules was not always sufficient to ensure investor protection. Efficiently and effectively enhancing such protection required that the consideration of the needs of the investor was not only anticipated at the very moment when a specific investment product is manufactured, rather than simply at the time it is offered or sold, but also maintained during the life-cycle of the product.

The ESMA Draft Guidelines are also of interest from another perspective, namely the one of attainment of convergence in the exercise of regulatory supervision. ESMA is called to play a bigger role in this respect as part of an organic growth of its competences since the time of its first establishment in 2010. We hear more and more these days about convergence in the exercise of regulatory supervision and that means ensuring that the same regulatory and supervisory outcome is obtained in similar circumstances. Convergence is a consequence of the changed landscape of the European regulation on financial services, after nearly ten years have lapsed since the last financial crisis.

Whilst at inception ESMA dedicated more effort in building the European rulebook, today that rulebook is in place and also very articulated, so ESMA’s role is shifting to ensure that the multitude of regulatory provisions are applied consistently across Europe. This aim underpins clearly the Draft Guidelines on product governance requirements under MiFID II. ESMA is providing assistance to National Regulatory Authorities and market participants alike in identifying through clear examples the areas where it is mandatory to obtain a similar understanding and similar outcomes – convergence, in other words – for the fulfilment of the investor protection goals. Namely, in this case, through identification of the target market as one of the main requirements under these enhanced new investor protection measures.  

Are the rules on product governance really new?
In the wake of Brexit, and in thinking about the participation of the United Kingdom in the European Union, it has emerged clearly, in more than one instance now, how the contribution made by the authorities in the United Kingdom has been pivotal in shaping many fundamental pieces of European legislation on financial services.

Whilst this will undoubtedly position the United Kingdom in a very favourable place when the time comes to definitively reconsider its relationship with the European Union under a different form than the passporting rights, it cannot go unnoticed how the United Kingdom has been at the forefront of innovation in financial services, with the product governance rules at issue being one of the many examples.

In fact, we say it is only with MiFID II that we see the introduction of product governance rules at European level. However, similar rules were already in existence in the United Kingdom under the form of regulatory guidance to principles, the so-called RPPD.

Without going into a detailed gap analysis of the RPPD rules against the ones introduced by MiFID II, it is sufficient to say for the purposes of this article that there are a few noticeable differences between the two sets of rules. First and foremost, the RPPD rules were conceived with the retail investor in mind, whilst the corresponding rules under MiFID II do not make this distinction and are applicable, accordingly, when products are manufactured and distributed to both institutional and retail investors. Also, whilst the MiFID II rules are binding, the same is not so clearly cut for the RPPD. A curious mechanism in the RPPD was envisaged, where any diversion from the rules would not amount per se to any violation or breach. On the other hand, however, compliance with the RPPD would have a favourable impact in the case of enforcement action.

The scope of the MiFID II provisions on product governance goes beyond the remit of the RPPD; this is what the FCA concludes in one of its most recent discussion papers on the implementation of MiFID II; the CP16/29. Most notably, even though the concept of target market was already envisaged within the RPPD,MiFID II product governance rules translate into additional systems and procedures to ensure that the entire lifecycle of the product is captured under the new requirements. Also, it is noteworthy to mention that not only the compliance function – which is a given – but also the management boards of the firms will have to be involved in the process of governance and held accountable for it.

In CP16/29, the FCA states that implementation of the new MiFID II rules will be an organic evolution of the existing rules, built on the regulatory infrastructure already in place. This will ensure that implementation of MiFID II in this regard will be seen as a natural progression of the work done so far.

Gold-plating – does it still make sense with Brexit?
More often than not, especially when debating implementation of MiFID II, there are rumours about potential gold-plating by local national authorities, with ensuing extension or reduction in scope of certain provisions of the recast directive.

A word of caution on this point is necessary, even more so today in light of the current historical and political situation. At these times of Brexit, with mounting uncertainty with regards to the future relationship between the United Kingdom and the European Union, the debate surrounding a potential gold-plating of MiFID II provisions in the United Kingdom is becoming a different issue, whose importance is inevitably diluted in certain aspects.

The current sentiment driving the movement to regain sovereignty of local laws over the ones of the European Parliament will realistically inspire some diversions, sometimes significant, from the text of the recast directive. The current market standard, which as we know in the United Kingdom has always been very high, could realistically prevail over any attempt to ensure identical approaches to the rest of European regulators which are not ingrained in local market practice. Product governance requirements, but also unbundling of research costs, are just a few of the examples. However, any gold-plating as such will have a different resonance in a changed political scenario, where full access to the single market and passporting rights may be substituted with a new way to deal with European affairs.