Embed Size (px)
Citation preview
The Implications on Retail Structured Products:
Product Governance and Intervention
Etay Katz
Partner
Allen & Overy LLP
®ISDA is a registered trademark of the International Swaps and Derivatives Association, Inc.
Copyright © 2014 - 2016 International Swaps and Derivatives Association, Inc.
Markets in Financial Instruments Directive II/Regulation
November 22, 2016
London
Outline
2
Investor Protection
• Summary of key elements of investor protection measures in MiFID II/MiFIR
Product Governance
• Product Governance: Overview
• Product Governance: Obligations for manufacturers
• Product Governance: Obligations for distributors
• Product Governance: The delineation of obligations
• Product Governance: Scope
Product Intervention
• Product Intervention: Overview
• Product Intervention: ESMA and the EBA
• Product Intervention: National Competent Authorities
• Product Intervention: EBA’s Technical Advice
Conclusions
• Implications for Retail Structured Products market
• Timing and next steps
Key elements of investor protection in MiFID II/MiFIR
include…
3
Increased transparency on costs
Framework for product intervention – NCAs, ESMA
and the EBA
Detailed product governance arrangements
Conflicts of interest
Best execution
Inducement ban (independent advice and
discretionary portfolio management)
New requirements in relation to provision of
client information
Requirement to inform clients if advice provided on “independent basis”
“Suitability” and “Appropriateness”
Product Governance
4
Product Governance - Overview
Key provisions of MiFID II:
– Recital 71
– Article 16 (3) MiFID II
– Article 24 MiFID II
– ESMA final technical advice on product governance obligations for manufacturers and
product governance obligations for distributors (Section 2.7, ESMA/2014/1569)
– Commission final draft Delegated Directive (April 2016)
Other relevant work taken into consideration in development of legislative proposals
includes:
– ESAs Article 56 Joint Position on “Manufacturers’ Product Oversight and Governance
Processes”
– IOSCO report “Regulation of Retail Structured Products” (FR14/13)
– ESMA opinion on “Structured Retail Products – Good practices for product governance
arrangements” (March, 2014)
5
Product governance - Overview
• MiFID II introduces a new EU product governance regime
• Purpose of product governance amendments include:
‒ ESMA considers sound product governance arrangements to be fundamental for
investor protection purposes
‒ Introduction of specific oversight, control and governance obligations for manufacturers
and distributors intended to ensure due consideration given to interests of investors
during each stage of the life of a product
‒ To avoid and reduce, from an early stage, potential mis-selling risk and help ensure
that new products and services are provided to the right investors
‒ Intended to reduce the need for product intervention
‒ Imposing positive duty on firms to check products function as intended and are in fact
being distributed to the target market as opposed to only requiring them to react when
detriment becomes apparent
6
Product governance obligations for manufacturers in ESMA’s
technical advice and final draft Delegated Directive include…
Procedures to
manage
conflicts of
interest
(including
remuneration)
properly
Necessary
expertise and
appropriate
training for
staff
Written
agreement
outlining mutual
responsibilities
if collaborate
with third party
in non-EEA
Member State to
create or
manage product
Management
body to have
effective
control over
product
governance
process
Identification
of events
affecting
material
risk/return and
taking
appropriate
action
Regular
reviews of
products to
investigate if
function as
intended
Scenario
analysis to
assess risk
poor investor
outcomes
Analysis of
charging
structure
including its
compatibility
with target
market
Identification
target market
and type(s) of
clients for
whom product
compatible at
sufficiently
granular level
Reviews of
whether
product
distributed to
target
market/clients
for whose
needs it is
compatible
7
Provision of
information to
distributors of
an adequate
standard
Compliance
function to
oversee
development
and periodic
reviews
Consider
whether
product meets
identified
needs,
characteristics
and objectives
of target
market
Will launch of
product affect
financial market
stability/orderly
functioning?
Product not
causing
problems with
market integrity
by enabling
issuer to
mitigate or
dispose of own
risks/exposure
Proposed product governance obligations for distributors in
ESMA’s Technical Advice and the final draft Delegated Directive
include…
Periodic
review of
product
governance
arrangements
to ensure fit
for purpose
Regular review
of products
offered and
distribution
strategy, taking
action if not
appropriate or
events identified
that could
materially affect
potential risk to
target market
Provide
manufacturer
with sales
information to
support
manufacturers’
reviews
When deciding
range of
products and
services offered,
must have
adequate
product
governance
arrangements to
ensure products
and services
compatible with
target market
Where product
issued/manufact
ured non-MiFID
firm/third-
country firm –
obtain product
information that
is reliable and of
adequate
standard
To obtain
information to
gain necessary
understanding of
products to
ensure
distributed in
accordance
characteristics,
needs,
objectives,
target market
Management
body to have
effective
governance
control over
range of
products,
services offered
and respective
target markets.
Compliance to
be involved in
development
and review of
product
governance
Staff to fully
understand
characteristics
and risks
products and
services as well
as
characteristics,
needs, and
objectives of
target market
When deciding
range of
products offered
and target
markets, must
have procedures
to ensure
compliance with
MiFID (e.g.
disclosure,
suitability/appro
priateness,
inducements,
conflicts)
Final
distributor in
chain with
direct client
relationship
has ultimate
responsibility
to meet
product
governance
obligations
8
Product governance: The delineation of obligations
• Manufacturers
‒ No definition. Article 16(3): “An investment firm which manufactures financial
instruments for sale to clients.”
‒ ESMA Technical Advice and the Delegated Directive include references to firms
which create, develop, issue and/or design financial instruments.
‒ Includes investment firms advising corporate issuers on the launch of new securities.
• Distributors
‒ No definition.
‒ ESMA Technical Advice: ‘Distributor’ refers to “an investment firm that offers and/or
recommends investment products and services to clients.” In this context, “offers”
has a wide application and is to be read in a broad sense. AND “The obligations for
distributors shall apply to investment firms when deciding the range of products
(financial instruments and structured deposits) issued by itself or other investment
firms and services they intend to offer to clients. These proposals also apply to
distributors selling investment products issued by entities that do not fall under
MiFID scope.”
‒ The Delegated Directive refers to distributors as investment firms which offer or
recommend financial instruments to clients.
9
Product governance – Scope
10
• “Target market” – ESMA refused to clarify the level of granularity required when identifying the “target market”. To be determined on a case by case basis.
• The preamble to the Technical Advice does consider at a very high level how the manufacturer and distributor obligations in this regard should be considered.
Scope of product governance
arrangements?
• Manufacturer obligations stated to apply to “investment firms manufacturing investment products.”
• Distributor obligations stated to apply to “investment firms when deciding the range of products …and services they intend to offer to clients.
• Inconsistent use of terms although intended to capture “financial instruments and structured deposits.”
• Both the manufacturer and the distributor requirements apply with respect to shares and bonds.
Scope of product governance
arrangements
• Product governance rules apply irrespective of the type of service provided and of the requirements applicable at point of sale.
• Investment firms providing crossing brokerage platforms will be subject to the distributor product governance obligations.
Distributor requirements to apply
to distribution products on
secondary market?
Product Intervention
11
Product Intervention – Overview WHO?
‒ ESMA mandate to monitor market for financial instruments marketed, distributed or sold in the Union (Article 39(1)
MiFIR)
‒ EBA mandate to monitor market for structured deposits marketed, distributed or sold in the Union (Article 39(2)
MiFIR)
‒ NCAs mandate to monitor the market for financial instruments and structured deposits marketed, distributed or sold
in or from their Member State (Article 39(3) MiFIR)
‒ MiFIR and the final draft Delegated Regulation give ESMA, the EBA and National Competent Authorities
extensive product intervention powers (Recital 29, Articles 40, 41 and 42 MiFIR and Articles 19 to 21 of the final draft
Delegated Regulation)
‒ EIOPA given similar product intervention powers in relation to insurance-based investment products in the PRIIPs
Regulation
WHAT POWERS?
‒ ESMA/the EBA may temporarily prohibit or restrict in the Union:
(i) The marketing, distribution or sale of certain [financial instruments/structured deposits] or [financial
instruments/structured deposits] with certain specified features
(ii) A type of financial activity or practice
12
Product Intervention – ESMA/EBACONDITIONS TO EXERCISE
‒ ESMA/the EBA may exercise intervention powers only if all of the following conditions fulfilled:
(a) Proposed action addresses a significant investor protection concern or threat to orderly functioning and integrity of
financial markets [or commodity markets] or the stability of the whole or part of the financial system in the Union
(b) Regulatory requirements under Union law that are applicable to the relevant financial instrument or activity do not address
the threat
(c) National Competent Authority/Authorities have not taken action to address the threat/the actions that have been taken do not
adequately address the threat
‒ Where above conditions are fulfilled, restrictions may be imposed on a precautionary basis before financial instrument/structured
product marketed, distributed or sold to client
‒ When taking action ESMA/the EBA shall ensure that the action:
(a) Does not have a detrimental effect on the efficiency of financial markets or on investors that is disproportionate to the benefits
of the action
(b) Does not create a risk of regulatory arbitrage, and
[(c) Is taken after consulting public bodies competent for the oversight, administration and regulation of physical agricultural
markets under Regulation (EC) No 1234/2007, where the measure relates to agricultural commodities derivatives]
‒ Before taking any action, obligation to notify National Competent Authorities and publish notice of decision to take action on its
website
13
Product Intervention – ESMA/EBAHOW WILL ESMA/EBA DETERMINE IF THERE IS A SIGNIFICANT INVESTOR PROTECTION CONCERN?
‒ Final draft Delegated Regulation specifies criteria and factors to be taken into account by ESMA/the EBA in determining when there is
a significant investor protection concern or threat to orderly functioning and integrity of financial markets or commodity markets or the
stability of the whole or part of the financial system in the Union
‒ These criteria and factors shall include:
(a) Degree and complexity of a financial instrument/structured deposit and the relation to the type of client to whom it is marketed and
sold
(b) The size or the notional value of an issuance of financial instruments/structured deposits
(c) The degree of innovation of a financial instrument/structured deposit, an activity or a practice
(d) The leverage a financial instrument/structured deposit or practice provides
The list of criteria in the final draft Delegated Regulation is exhaustive
HOW LONG DO THE RESTRICTIONS LAST?
‒ ESMA/the EBA to review prohibition/restriction every at appropriate intervals (at least every 3 months). If not renewed after that 3
month period it shall expire
ESMA INTERVENTION POWERS PREVAIL
‒ Action adopted by ESMA/the EBA under Articles 40 and 41 MiFIR to prevail over any previous action taken by a NCA
14
Product Intervention – National Competent
AuthoritiesWHAT POWERS?
– National Competent Authorities may prohibit or restrict the following in or from that Member State (note not “temporarily restrict”):
(i) The marketing, distribution or sale of certain financial instruments/structured deposits or financial instruments/structured
deposits with certain specified features
(ii) A type of financial activity or practice
CONDITIONS TO EXERCISE
– National Competent Authorities may exercise intervention powers only if satisfied on reasonable grounds that:
(a) (i) A financial instrument/structured deposit/activity/practice gives rise to significant investor protection concerns
or poses threat to orderly functioning and integrity of financial markets or commodity markets or the stability of
the whole or part of the financial system within at least one Member State; or
(ii) a derivative has detrimental effect on the price formation mechanism in the underlying market;
(b) Existing regulatory requirements under Union law that are applicable to the relevant financial instrument, structured
deposit or activity do not sufficiently address the threat and the issue would not be better addressed by improved
supervision or enforcement of existing requirements;
(c) The action is proportionate taking into account risks identified, sophistication of investors/market participants, likely
effect of action on investors/market participants who may hold/use/benefit from the financial instrument, structured deposit or
activity or practice
15
Product Intervention – National Competent Authorities
(d) Properly consulted National Competent Authorities in other Member States that may be
significantly affected by the action
(e) The action does not have a discriminatory effect on services or activities provided from another
Member State; and
(f) It has properly consulted public bodies competent for the oversight, administration and regulation
of physical agricultural markets under Regulation (EC) No 1234/2007 where applicable
‒ Where above conditions are fulfilled, restrictions may be imposed on a precautionary basis before
financial instrument/structured deposit marketed, distributed or sold to client
‒ Obligation to notify all other National Competent Authorities and ESMA not less than one month
before the measure is intended to take effect (giving evidence for decision and that each of the
conditions in Article 42(2) met) including giving evidence upon which decision based
‒ Where urgent action required to prevent detriment arising National Competent Authority may take
provisional action for up to 3 months with no less than 24 hours notice to all other National
Competent Authorities and ESMA/EBA
‒ Notice of decision to impose prohibition/restriction to be published on website of National Competent
Authority before measures take effect
16
Product Intervention – National Competent Authorities
HOW WILL NATIONAL COMPETENT AUTHORITIES DETERMINE IF THERE IS A SIGNIFICANT
INVESTOR PROTECTION CONCERN?
– The final draft Delegated Regulation specifies criteria and factors to be taken into account by NCAs in
determining when there is a significant investor protection concern or threat to orderly functioning and
integrity of financial markets or commodity markets or the stability of the whole or part of the financial
system within at least one Member State
– These criteria and factors include:
(a) Degree of complexity of the financial instrument/structured deposit in relation to the type of client to
whom it is marketed and sold
(b) The degree of innovation of a financial instrument/structured deposit/activity/practice
(c) The leverage a financial instrument/structured deposit or practice provides
(d) In relation to the orderly functioning and integrity of financial markets or commodity markets, the size
or the notional value of an issuance of financial instruments or structured deposits
The list of criteria in the Delegated Regulation is not exhaustive
17
Product Intervention – National Competent Authorities
ESMA/EBA OPINION
–After receiving notice of any action under Article 42 MiFIR. ESMA/EBA
shall adopt an opinion on whether the action is justified and
proportionate
– Where a National Competent Authority proposes to take/takes action/declines
to take action contrary to an ESMA opinion, it shall immediately publish a
notice fully explaining its reasons
HOW LONG DO THE RESTRICTIONS LAST?
– To be revoked by National Competent Authority if the conditions in Article
42(2) no longer apply
18
Product intervention - EBA’s technical advice
– EBA agreed that structure, criteria and factors proposed in MiFID II/MIFIR
Consultation Paper should generally apply to structured deposits
– Factors should not apply cumulatively – intervention may be justifiable where
only a subset of criteria met
– Criteria presented in the technical advice are generic, flexible, non-
quantitative and non-exhaustive
– The EBA technical advice differs to ESMA’s in a number of respects, primarily
due to the fact that structured deposits are generally lower risk due to the
coverage afforded by a deposit guarantee scheme and that the terms require
full repayment at maturity
19
Implications for Retail Structured Products - “It’s
life…but not as we know it”
– Impact on markets, firms and regulators (in particular when viewed together
with other investor protection provisions in MiFID II/MiFIR)
– Product governance: change in focus to reduce risks of misselling before
products are launched rather than only requiring reaction when detriment
becomes apparent
– Disclosure is not enough
– Product intervention: new powers and new strongarm approach to
enforcement
– In the UK product governance and product intervention powers not alien but
MiFID II/MiFIR will introduce similar regimes into other Member States
20
Timing and next steps
21
May 2014: ESMA published a
consultation and discussion paper
12 June 2014: Text of MiFID II and
MiFIR published in the Official Journal
December 2014:
ESMA published CP and final technical
advice
February 2015:
ESMA published additional CP
June & September 2015:
ESMA submitted final technical
standards to the EC
April and May 2016: EC to adopt
delegated acts
January 2016: ESMA to submit final technical
standards
3 July 2017: Member States must adopt and
publish the measures
transposing MiFID II into national law
3 January 2018: MiFID II Directive
and MiFIR to apply (subject to
a small number of excepted Articles)
22
Questions?
These are presentation slides only. The information within these slides does not
constitute definitive advice and should not be used as the basis for giving definitive
advice without checking the primary sources.
Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term
partner is used to refer to a member of Allen & Overy LLP or an employee or
consultant with equivalent standing and qualifications or an individual with
equivalent status in one of Allen & Overy LLP’s affiliated undertakings.
