EBF advisor: Simon Pettinger Kearney
Publication date: 05 January 2017
The EBF welcomes a flexible and proportionate approach to the target market assessment which allows for adjustments to the nature of the product and investment services provided.
Coherence/coordination with suitability assessment:
The Guidelines acknowledge that product governance and suitability assessments serve different purposes. However in the EBF view, the Guidelines1 underestimate the impact that the target market definition has on the suitability assessments. In practice, the granularity of the categories to be considered will require firms to fundamentally review their client classification and not all categories that need to be considered for the purpose of target market identification are captured by the client classification that firms use for MiFID purposes (suitability/appropriateness). As a matter of fact, distributors not only need to establish procedures to gather all the information on their clients necessary to properly assess the actual target market, but also have to monitor the adherence to the target market on a case-by-case basis when interacting with their clients. It would therefore be useful to clarify the necessary coherence and coordination between product governance rules and the suitability assessment. Moreover, the different roles and responsibilities of manufacturers and distributors require further distinction. For example, the role of manufacturers should not be expanded to include defining in detail the distribution channels to be used; this responsibility should fall to the distributor given its more appropriate expertise. Whilst we support ESMA’s efforts to ensure further alignment between manufacturers and distributors, they do have different roles and expertise, and achieving the increased client protection that ESMA desires will be best delivered by recognising these differences.
Secondary market transactions:
The EBF takes the view that further clarification is needed regarding the application of the product governance rules to secondary market transactions e.g. shares and bonds traded on a trading venue. We note that the term “manufacturer” under MiFID II includes “investment firms that create, develop, issue and/or design financial instruments, including when advising corporate issuers on the launch of new financial instruments” (Recital 15 of MiFID II Delegated Directive). However, to our understanding, this does not mean that investment firms providing services in relation to an IPO in shares should be considered manufacturers for all subsequent secondary market trading. Instead, the corporate issuer should be considered as the non-MiFID manufacturer and the investment firm transmitting a client’s order for execution on venue should be responsible for identifying the target market. Hence, in accordance with ESMA’s Guidelines and the principle of proportionality, the investment firm should then be able to use a simplified approach for identifying target market, e.g. based on the fact that the instruments are non-complex and intended for the mass-market. There should be no need to enter into a separate agreement with corporate issuer or to report back information regarding sales etc. As a matter of fact, in the absence of a distribution agreement, many of the obligations provided by the MiFID II Delegated Directive in relation to product governance could not be effectively applied and some adaptations/simplifications are needed regarding the definition of the target market (See Q3 and Q5).
Target market categories and assessment:
The set of categories to be used in defining the target market need to be simplified as follows: i) “Clients’ Objectives” should be solely linked to the investment horizon and not also to other items such as liquidity supply or retirement provision, as the time horizon together with the risk profile are the main factors applied to identify the financial characteristics of an investment product; ii) “Clients’ Needs” should be merged with Client Objectives. This is difficult, if not arbitrary, to identify clients’ needs differently from the financial characteristics of an investment product. Furthermore, it should be clearly stated in the Guidelines that for non-advised services relating to simpler and more common products (see paragraph 17 of the Guidelines) the target market could be formed by all the firm investment services clients (i.e. the clients of all the abstract groups on which the firm’s client base is divided, for the purpose of the guidelines).
Deviations from the target market that result from proper portfolio diversification objectives should not be seen as an exception but as a key element for investor protection. In this sense, target market identification should not only consider the product when individually assessed but also when part of a broader investment portfolio. There is a need to recognise that the priority is to ensure that clients have an appropriate portfolio of products that spreads according to their preferences in the risk/reward profile, and consequently even a volatile instrument may find its place in a defensive portfolio. An overly restrictive approach in the definition of the target market can prevent the creation of portfolios with an appropriate risk balance. The aim of initial target market to prevent mis-selling, and not with portfolio building in mind.
Moreover, it is unclear in which situations a firm is considered to “recommend and actively market” a financial instrument (Paragraph 43 of the draft Guidelines, page 29), as opposed to providing execution-only services (Paragraph 41 of the draft Guidelines, page 29). We note that according to the draft Guidelines, such a distinction will have a significant impact on the scope of the obligations of the investment firm e.g. whether to conduct a “more thorough assessment of the target market assessment”. In our opinion, a firm that only provides clients with the possibility to purchase and sell financial instruments in a pure execution only mode does not mean that the firm “recommends and actively markets” these instruments.
Overall, we fear that by imposing too stringent criteria in the target market definition at the manufacturer level would imply in the long run that many products will no longer be available to clients, contradicting the CMU objectives of jobs and growth. However if manufacturers impose restrictive criteria to the distributors these in turn will prevent products being offered to investors that do not exactly fit their profile. As a consequence, the risk-balance at investor level may tilt towards low risk products not because of the investor benefit, but because intermediaries want to limit legal liabilities.
Target market for investment services:
The EBF notes that the rules on product governance in MiFID II apply to financial instruments and structured deposits. However, at Level 2 (Article 10(1) MiFID II Delegated Directive) and also in the CP (paragraph 10 page 5), it appears as if the obligations for distributors have been extended to “services”. The EBF questions if such a requirement to identify target market for investment services is in line with Level 1, and require further clarity as to what “services” actually means in practice.
Exchange of information and data protection issues:
The EBF is concerned how the requirements regarding client information interact with rules on data protection. It is currently unclear whether such requirements on Level 3 such “legal obligations” that would allow firms to compile and process such information without being in breach of data protection rules. We also note that information sharing between manufacturers and distributors in some cases could be sensitive from a bank privacy and competition law perspective. This will be a particularly significant issue when dealing with non-MiFID and/or third country institutions.