Product governance Emerging best practice. March 2015 Paul Edmondson and Simon Morris CMS London

Transcription

1 Product governance Emerging best practice March 2015 Paul Edmondson and Simon Morris CMS London

2 Introduction 1. Why s this on the agenda? a) Recent FCA action 2. It s all about governance a) Procedures owned by business b) Part of internal risk & control framework 3. What procedures? a) Target market b) Product testing & monitoring c) Selecting distributor d) Information for distributor 4. And what about the distributor? 5. So what does good look like? 2

3 Your reading list includes 1. FSA: TCF in product design (July 2007) 2. FSA: Responsibility of Providers & Distributors for the fair treatment of customers (July 2007) 3. FSA: Guidance Consultation: Retail Product Development and Governance Structured Products Review (November 2011) 4. ESMA: Structured retail products - good practices for product governance arrangements (March 2014) 5. EIOPA: CP-14/150 Consultation Paper on the proposal for Guidelines on product oversight & governance arrangements by insurance undertakings (October 2014) 6. EBA: Draft Guidelines on product oversight and governance arrangements for retail banking products (November 2014) 3

4 A long-standing concern We want to develop a regulatory approach that looks at the whole product life cycle, the product value chain, including upstream processes product development and design as well as downstream activities marketing, distribution and post-sale handling... firms should identify the type of customer for which a product or service is likely to be appropriate... This means being clear about what the product does, who it is for and certain key characteristics such as the nature and scale of risks presented.... it is incumbent on providers to explore and understand their distributors information needs and ensure, as far as possible, that distributors are getting the right messages about what particular products do FSA speech January

5 UK policy evolves we will intervene earlier in a product s lifespan and seek to address root causes of problems for consumers. We will do this by scrutinising firms product governance how firms design, operate and sell products... [to] set outcome-focused responsibilities on firms to govern the design and delivery of products in a way that delivers fair results. Provider firms will be expected to have robust procedures to assess their target market, perform adequate stress testing, and manage the product risks for consumers... It is likely we will go further than the FSA has previously done in challenging providers on the value-for-money of their products and checking that charging structures can still ensure good outcomes for consumers. Journey to the FCA October

6 The call to action Poor product governance can cause conduct risk in a number of ways. Unconscious consumer biases are inherent and can be manipulated by product design and sales processes. There may also be a lack of oversight over a product s lifecycle, which may lead to complex or unclear products that are not in the best interest of consumers.... we will carry out thematic reviews of firms product governance processes across retail and wholesale markets to ensure that the outcome is appropriate for consumers. We will take tough action if standards are not adequate... FCA business plan 2013/14 6

7 And now, MiFID II Product governance Product governance procedures are required for product manufacturers and distributors. Firms which manufacture financial instruments for sale to clients will be required to maintain a product approval process. Firms which offer or recommend financial instruments they do not manufacture must also have in place appropriate governance arrangements, including ensuring that they understand the features of the products they distribute. The appropriate target market for each product will have to be identified. 7

8 ESMA Enhanced Protection for Retail Investors Product governance arrangements will apply to firms that manufacture products as well as firms that sell financial products. The requirements are designed to ensure that firms understand the nature and risks of the products they are manufacturing and/or selling to you. Therefore firms will be required to identify the target market for each product and ensure that all relevant risks are assessed and understood before a product is distributed to you. They must also ensure that the product is only distributed to those investors for whom it was actually designed. 8

9 What does product governance entail? 1. Governance & oversight arrangements 2. Product design; 3. Target market; 4. Price and value; 5. Product testing; 6. Distribution strategy; 7. Review process. 9

10 And the target is... many firms were unsure of their proper role in circumstances where the product lifecycle involves more than one firm. The FSA s starting point is that a customer s experience should not be affected by whether a product was provided and distributed by a single institution or by several. FSA Speech August

11 1. Product governance & oversight arrangements Manufacturers & distributors should establish and implement product oversight and governance arrangements. Written, approved by the board & widely distributed Transparent, consistent & auditable Designed to minimise potential consumer detriment Provide for proper management of conflicts of interest Ensure that the interests, objectives and characteristics of consumers are taken into account. 11

12 And the contents? 1. Steps to be followed before a product is manufactured or distributed 2. Roles, powers and responsibilities of the staff involved 3. The records to be kept 4. Providing overarching senior management accountability 5. Ensuring that the arrangements do not rely excessively on the judgment and discretion of a limited number of individuals 6. Involving Risk and Compliance in the arrangements 7. Define all interactions and flows of information between manufacturer and distributors 8. Regular review and update 12

13 Duty of the board The board is responsible for setting product strategy and ensuring products deliver the right outcomes for consumers. The board is also responsible for Establishing Implementing Reviewing Ensuring compliance with the product oversight and governance arrangements. 13

14 Trained staff The manufacturer should ensure that any staff tasked with designing a product 1. Follow the manufacturer s product oversight and governance arrangements 2. Are fit and proper 3. Are appropriately trained to understand a) The product s main features and characteristics b) The interests, objectives and characteristics of the target market 14

15 2. The principles of product design 1. it is good practice for manufacturers to ensure they meet the financial needs, investment objectives, knowledge and experience of the target market identified by the manufacturer. 2. The choice of underlying assets must be driven primarily by the demands of the potential target market and not internal needs, e.g., to offload assets or liabilities from the manufacturer s own balance sheet or trading book. 3. It is good practice for the compliance function to be involved in the product design process and be entitled to intervene at every stage. 15

16 4. It is good practice for manufacturers to use modelling and statistical test analysis manufacturers should conduct robust, unbiased and arbitrage-free testing so as to allow for an external party to adequately challenge the pricing, valuation, and risk/reward trade-off relative to the target market. 5. It is good practice for manufacturers to ensure that appropriate information is made available to distributors concerning the products they manufacture. 6. It is good practice for firms to ensure that product key features are visible for distributors and retail investors. This implies making clear the design and the expected returns and risks, including the potential for partial or full loss of invested capital. 16

17 3. Target market Policies to support design of product appropriate to target market Appropriate matching of products to customer needs of target market Clear understanding of what customer needs the product will fulfil Target market plausible Products designed to meet customer needs More of a flavour from the FCA The FSA s experience with many product mis-selling issues has been that products designed for a specific market were sold widely outside it. By putting more responsibility on providers to ensure that products only reach the customers they were designed for and that they function as expected there should be far fewer incidents of major consumer harm. 17

18 The manufacturer should identify the relevant target market of a product and the groups of consumers for which the product is considered likely not to meet their needs. When deciding this the manufacturer should assess the level of information available and the degree of financial capability of the target market. The manufacturer should only design and bring to the market, products with features, charges, risks and distribution channels that meet the interests, objectives and characteristics of, and are of benefit to the identified target market [and assess whether a less complex, costly or risky product could meet the demands and investment objectives of the target market identified] 18

19 4. Price and value Deliver value for money Design driven by features that benefit customer Product costs are compatible with benefits More of a flavour from the FCA It is likely we will go further than the FSA has previously done in challenging providers on the value-for-money of their products and checking that charging structures can still ensure good outcomes for consumers. 19

20 5. Product testing The manufacturer should conduct appropriate testing of the product and scenario analyses before it is Designed and brought to the market Offered to a new target market Or changes to an existing product are introduced Simulated future performance to assess whether likely outcomes meet the investment objectives of the target market and whether the risk/reward trade-off is fair for its target market. It is good practice for manufacturers to advise distributors and for them to ensure they are aware of and understand the results. Distributors should critically examine these and, if needed, employ an independent expert. Back testing 20

21 Example testing & targeting considerations a new insurance product Life product What would happen to the risk and reward profile of the product following changes to the value and liquidity of underlying assets? How is the risk reward profile of the product balanced, taking into account the cost structure of the product? When a product benefits from a certain tax environment or other condition; what happens if these conditions change? What are the terms and conditions, and how do they affect the outcome of the product? What will happen if the consumer terminates early the contract? Non-life product What is the expected claims ratio and the claims payment policy? What if it is higher or lower than expected? Do the expected claims ratio and claims payment policy suggest that the product is of benefit to consumers? Does the coverage of one product potentially overlap with the coverage of another product? Does the coverage meet future needs of target market? How is the coverage updated in terms of reflecting future needs of target market? Do consumers understand the terms and limitations of the contract? 21

22 6. Distribution channels Firms should carry out due diligence on distributors: initial due diligence would include an assessment of any risks posed to the fulfilment of the firm s legal and regulatory responsibilities; and continuing due diligence would include monitoring their distributors to ensure that products are reaching their target market. Firms should provide appropriate information and in sufficient detail to distributors Firms should assess the nature and complexity of the product to determine the likely training needs and other support required by distributors (FSA Nov 2011) 22

23 The manufacturer should select distribution channels that are appropriate for the target market Due diligence Meeting management Documenting responsibilities Training have the appropriate knowledge to correctly place/distribute each product on the market. give the proper information and/or advice to the consumer. 23

24 The manufacturer should provide information to distributors of an adequate standard, clear, precise and up-to-date sufficient to enable them to: understand and place the product properly on the target market, identify the target market for which the product is designed and consumers for which the product is considered likely not to meet their interests, objectives and characteristics, extract the relevant information that needs to be communicated to the consumer. 24

25 The manufacturer should also Take all reasonable steps to ensure that distribution channels observe the product governance arrangements. Take remedial action when required Training Information Halting distribution Regularly verify that the product is being distributed to the target market. Manufacturers could survey a number of consumers to find out if they understood the product features and to see if they fit into the target market. Regularly meet and assess the distributor s performance. 25

26 So what does that leave for the distributor? 1. Know the market 2. Get adequate information from the manufacturer 3. Understand the target market 4. Responsible for marketing material (provided manufacturer provides accurate material) 5. Wholly responsible for individual suitability 26

27 7. Product monitoring Once the product is distributed, the manufacturer should monitor on an on-going basis that the product continues to meet the interests, objectives and characteristics of the identified target market. Claims Complaints Persistency Product usage 27

28 Remedial action The manufacturer should advise customers if a product performs differently from expectation. The manufacturer should take appropriate action to mitigate a problem and prevent the recurrence of detriment. The manufacturer should notify remedial action promptly to the distributor involved and to the consumer in case of direct sales including information on changes or modifications to the product. 28

29 What good looks like. Provider a) Governance committee b) Ascertaining need Panelling products Periodic review c) Dealing with distributor Select Train Dialogue Review d) Accurate product material Drafting points Taking a proper view Can the customer assess the risk & return? Distributor a) Governance committee b) Checking provider & product Engaging with provider Ensuring understand product c) Accurate marketing material d) Proper sales process e) Getting & acting on feedback

30 And a cautionary tale The CSI/YBS structured deposits enforcement case 30

31 Who did what? Manufacturer 1. Sold swaps 2. Plan manager 3. Retail customer relationship 4. Wrote brochure Distributor 1. Bought swaps 2. Deposit taker 3. Overall customer relationship 4. Wrote other material 31

32 How to read the case Narrowly (and only partially right) Wider (and correctly) 1. Financial promotions must be accurate 2. A manufacturer is liable when it s in a direct customer relationship 3. The manufacturer wrote the brochure so of course it s liable 1. A manufacturer and distributor share responsibility for products where each contributes 2. A manufacturer and distributor must have a detailed dialogue throughout the process 3. This regulatory liability is wider than and different to legal liability 32

33 The charge Breach PRIN 7 customers information needs & communications clear, fair and not misleading (both provider & distributor) The main distributor (FCA Final Notice YBS June 2014) 56,000 investors deposited 545m Unsophisticated & stepping stone product. The provider assessed the Cliquet Product as low-risk, non-complex and suitable for non-advised sales to retail customers. 33

34 What did the product offer? Capital protection Guaranteed minimum % for 4 6 year versions Distributor knew 40 50% chance this would be the outcome This was the outcome with 59% of maturities Potential for more if FTSE performed well, subject to cap 20 72% for 4 6 year versions Distributor knew 0% likelihood of achieving the maximum 41% of maturities exceeded minimum by average 2.57% overall 34

35 What weren t customers told? As would be expected, the model driven probabilities suggest approximately a 50% chance of receiving only the minimum return (when the market falls or is flat), and a strong possibility of achieving AERs above this (up to around 4.5% AER, or 5% to 6% AER for longer maturities), and then a limited and decreasing possibility at higher levels. The back testing does not reveal instances of all periods hitting the Cap % to produce the highest level of return. This is consistent with the low probability recorded for this occurrence, and should be noted in the product documents. Provider Product Pack for Distributor on tranche review 35

36 Consequently the provider s brochure gave undue prominence to the potential maximum return notwithstanding the fact CSI knew, on the basis of its own analysis, it was almost impossible to achieve the maximum return it was highly inappropriate to emphasise the maximum return in this way. This led to an unfair presentation of the likelihood of achieving the maximum return (and consequently the overall likely return) In order to understand the likelihood of achieving anything above the minimum return potential customers required a high level of sophistication and experience... FCA Final Notice CSI June

37 What bad looked like 37

38 The FCA requirement 1. Customer contact and redress exercise 2. Methodology 3. Compensation 4. What the parties had to do 38

39 And from the horse s mouth This case was also interesting because we took action not just against YBS the distributor but also CSI who had designed the product and the marketing material. Responsibility for ensuring good consumer outcomes does not all lie at the end of the distribution chain. Tracey McDermott (FCA 22 July 2014) 39

40 Any questions? 40