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MiFID II and Structured Products: Product Governance

Josh Wynn, Lowes Financial Management

21 February 2018

One MiFID II topic led to most of our communication with structured product providers: the new requirements regarding product governance. Governance received a spotlight role in MiFID II’s supplementary material; new requirements have prompted the general inclusion of Key Information Documents (KID) alongside product brochures, as well as the identification of a ‘Target Market… at a sufficiently granular level’ for each and every plan and additional requirements to update investors on the performance of their investments throughout their terms. The general aim seems to be an increase in awareness: for manufacturers and distributors, of who is investing in their products; for investors, how their investment works and performs from bean to cup. The latter of the alterations stated above pointedly seeks to diminish the view of structured products as ‘fire and forget’ investments.

KID

The Key Investor Information Document is now legally required to be presented accompanying structured product brochures. Unlike brochure design, KIDs vary very little in appearance between products, as they are technical documents issued by the counterparty bank rather than by the consumer-friendly face of providers.

The KID should detail the relevant parties involved in the product; the underlying index; risk profiling; performance scenarios and much more. In other words, the KID should be the bare bones of the product brochure, undressing everything that providers are obliged by law to supply to retail clients. To ensure that we do our part in providing users of our website with the necessary documentation, you will find the KID downloadable there, the file combined with that of the product literature. In future, if a product’s literature does not meet the new requirement to include the KID it will not be available through our site.

Target Market

Article 16.3 of MiFID II states that ‘The product approval process shall specify an identified target market of end clients for each financial instrument and shall ensure all relevant risks to such identified target market are assessed and that the intended distribution strategy is consistent with the identified target market.’ We have already seen the implications of Article 16 playing out in relation to the KID, with the requirement to state the target market for the investment. The level of detail given to the new addition has ranged from barely a quarter of a page to a two-page expansion of the ‘Is the Plan right for me?’ section in some. The provision of a target market for structured products will no doubt be a useful resource to advisors and retail clients alike when assessing the suitability of a potential investment.

The main complication identified so far is the latter demand ‘to ensure… that the intended distribution strategy is consistent with the identified target market’. Indeed, this point is further developed in the supplementary material, requiring ‘investment firms to ensure that the provision of information… to enable distributors to understand and recommend or sell the financial instrument properly.’ The question is raised as to whether those distributing products (perhaps even individual IFAs) must inform those further up the supply chain of what may be regarded as divergences from the target market that has been outlined; on the other hand, the relationship implied could simply be one of additional information heading from providers in the direction of sub-distributors and IFAs, rather than the other way around. Here is an example of one of the finer points of MiFID II that is yet to be lent clarity. What is clear, however, is that advisors, product panels (where applicable) and clients should all be aware of the Target Markets of individual plans, and be able to provide evidence of its consideration when necessary.

Investor Updates

MiFID II states that those investing in investment products should receive regular updates throughout the lives of their individual investments. This may mean little real change in most cases, including structured products, as investors are already intermittently issued with correspondence regarding the performance of their plans, which are regularly reviewed by investments committees gauging whether any action need be taken on a case-by-case basis. In the words of one provider source: ‘we constantly monitor products in issue to determine if the performance of an underlying reference asset is a cause for concern that needs to be brought to the attention of customers and their advisers’. The extent to which there is any actual review by providers may vary.

When the underlying index is the FTSE 100 it is unclear what a provider could add in terms of review, but beyond structured products, advisers are now required to conduct periodic reviews that reaffirm the suitability of any recommendations. Due to the long-term nature of structured products and the intention at outset (at least in the retail sector) to buy and hold, we are curious as to what additional value ongoing advisor reviews might add, other than, perhaps, in the final months leading to maturity.

MiFID II has now been in force for over a month. In that time, the initial press mania has cooled somewhat, but issues with the regulation continue to bubble up to the surface as implementation reveals its implications on day-to-day business. For now, we await the next round of confusion to emerge. With any luck, this will be the last you hear about it from us.

Wishful thinking?