Asset managers have been living with MiFID II for close to a decade.
But while that might seem like it’s more than enough time to get to grips with the directive’s admittedly complex requirements, it turns out many aren’t as compliant as they thought they were.
Or, at least, that’s what the Financial Conduct Authority discovered, according to the findings of a review they published on 26 February 2021.
Here’s a look at the FCA’s key findings, plus some tips on improving your firm’s MiFID II compliance which you can start implementing straight away.
What was the scope of the FCA’s review?
The FCA’s review focused on product governance. In other words, the FCA aimed to find out whether firms:
- Are taking MiFID II’s product governance rules into account when creating, offering, or recommending investment products. Enhancing investor protection is a cornerstone of MiFID II, and these rules are one of the key ways the directive seeks to achieve that goal
- To what extent do they consider clients’ interests at every stage of the product’s lifecycle
The FCA picked eight asset managers and chose one product from each firm to review. The products were all UK-authorised collective investment schemes that were either launched after MiFID II’s implementation deadline — January 2018 — or changed significantly after that date.
So what were the key findings?
And, more importantly, where did the firms the FCA inspected fall short?
A look at the FCA’s key findings: how do firms get product governance wrong?
The FCA’s report is organised into four main categories:
- Product design
- Product testing
- Governance and oversight
Let’s take a look at the key findings in each category.
‘Negative target market’ — the type of investor a product is not suitable for — maybe the most unfortunately-named concept in regulatory history.
It’s also the MiFID II product governance rule firms struggle with most.
According to the FCA, only one firm it inspected had considered which people their investment products are unsuitable for. And they couldn’t identify who these people were.
Worse, in one case, the negative target market overlapped with the positive target market. The product wasn’t suitable for those with a time-horizon of more than 5 years, but nothing stopped them from investing in it for longer.
Conflicts of interest policies also fell short.
All the firms had a framework for managing them, but ticking boxes isn’t enough. What’s more important are the outcomes. For a framework on conflicts of interest to be truly effective, it should address these two issues:
- Do products have characteristics that benefit the firm at investors’ expense?
- Are there incentives to favour one group of investors over others?
How do products perform in different scenarios? And what happens if something goes wrong?
While all firms the FCA inspected carried out scenario analyses and stress testing, there were huge differences in approach and thoroughness.
In particular, some firms didn’t go far enough when stress-testing product-specific variables like underlying assets, the impact of adverse market conditions (including on their own financial position), and what would happen if the product were sold disproportionately to a certain category of investors.
And some firms relied too much on historical data while neglecting recent developments.
There were also issues with fee disclosures.
When the FCA carried out a review in 2019, it found that many firms didn’t display their fees prominently enough or disclose all of them, and concluded this was unfair. Unfortunately, not much has changed in 2021.
There were also discrepancies between the fees included in marketing literature and those key investor information sheets and other regulatory documents.
Third-party distributors are a critical part of asset managers’ businesses. But are firms sure the distributors they work with are fit for purpose?
According to the FCA’s findings, not necessarily.
Their review found due diligence was hit or miss, with some firms even claiming it doesn’t add much value.
Firms also admitted they found it tricky to get data on their distributors’ clients and to feeling awkward about pushing for it because of its commercial sensitivity.
Data monitoring systems and procedures also varied in quality. And management information wasn’t always granular enough, not reviewed regularly, and used inconsistently when designing products.
Governance and oversight
Here, the FCA uncovered four problem areas.
Firstly, product governance committees’ second lines of defence
e tend to have poorly defined roles, so their contributions are often limited.
Secondly, the quality of non-executive directors’ contributions differs from one firm to another. In some instances, non-executive directors typically get involved only if they feel they have the right expertise, so issues aren’t always tackled proactively.
Thirdly, record-keeping is poor across the board. Most firms don’t document challenges, checks, and decisions. This is problematic from an accountability perspective, especially now that the Senior Management and Certification Regime has come into force in full.
Lastly, the quality of training is variable. Staff should thoroughly understand the products they sell. But, just as important, they should thoroughly understand their customers’ needs and whether those products meet them.
Putting MiFID II compliance back on track
If the FCA’s review results are less than inspiring, it’s not all bad news. The report is also very clear about the FCA’s expectations. And you can use this guidance to make sure you’re not making the same mistakes.
But what steps should you take to improve your MiFID II product governance?
For starters, you should review your current product design and product testing processes:
- Build a profile of the type of investor your products would not be suitable for, and make sure the profile of your ideal investor isn’t so broad it overlaps
- Check that your schedule of fees is accurate and complete and displayed prominently in your literature
- Is the tail wagging the dog when it comes to product design? Perhaps your products have risks you might not have considered properly which would benefit your firm at investors’ expense? Or maybe you’re designing products with a very specific investor in mind?
- Are your scenario analyses and stress tests comprehensive enough? Make sure:
- You cover a long enough period of time
- The conditions in your stress tests are tough enough
- You take your firm’s financial position into account where that makes sense
- You consider how your customers would be affected
Your second line of defence should have a clearly defined role.
Secondly, make sure your governance framework is effective. More to the point, you should make sure you’re actively involving them and keeping detailed records of audits, checks, and decisions.
Last and most important, you need access to the right data.
And that’s where Fundipedia can help.
Our platform automatically collects data from a huge range of static and dynamic sources, including vendors, third-party administrators, and distributors. This means you don’t have to waste time chasing after outstanding information requests and other missing data.
The data is also organised in your preferred format. Whether you need portfolio data, performance data, or information about fees and costs, you can pull it up in just a few clicks so you can make key decisions — and ensure you stay compliant — with confidence.
Best of all, our reconciliation module automatically verifies all the data you’ve sent downstream and alerts you to any issues. This means you won’t have to worry about discrepancies between the information in your literature and regulatory documents and what you’ve sent downstream.
The FCA is watching…
If you thought you were nailing MiFID II compliance — or that, at least, you were very close — the FCA’s report should be a wake-up call.
MiFID II’s implementation deadline may be four years, several new regulatory initiatives, and a global pandemic in the past. But that’s no excuse to let things slip. The FCA expects firms to comply not just with the letter of the rules, but also with their spirit.
The FCA has also said this review is only the start. Further reviews and, potentially, regulatory updates will enhance MiFID II’s product governance framework. So there’s no time like the present to review and improve your product design and testing processes, strengthen your governance arrangements, and make sure you have the right data in place to help you stay compliant.
Don’t get caught out.
Need help getting access to the right data and making sure it’s well-organised, readily accessible, and always accurate?