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ESMA final guidelines on product governance and target market

ESMA final guidelines on product governance

In response to feedback, ESMA has refined some of the descriptions and has merged the two draft categories of clients’ objectives and clients’ needs, as the distinction between then was unclear.

Julie Patterson

Wealth & Asset Management, EMA FS Risk & Regulatory Insight Centre

KPMG in the UK


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There are now five categories that must be considered by product manufacturers and distributors, using both quantitative and qualitative criteria:

  • Type of client – the MiFID II categories of retail, professional or eligible counterparty.
  • Knowledge and experience – knowledge of eg the product type, how it works, the likely outcomes, special features etc; experience might be eg how long the investor has been active in the financial markets, invested in that type of product or product features etc. Knowledge and experience may be dependent on each other (eg if a client has good experience but little knowledge of the particular product, or vice versa). 
  • Ability to bear losses – the manufacturer must specify the percentage of losses target clients should be able and willing to afford, and if there are any additional payment obligations that might exceed the amount invested. This could be phrased as a maximum proportion of assets that should be invested.
  • Risk tolerance – the general attitude that target clients should have in relation to the risks of investment. Firms can use the PRIIP KID or UCITS KIID risk indicator to fulfil this requirement.
  • Clients’ objectives and needs – reference could be made to eg expected investment horizon, specific age demographic, clients’ country of tax residence, currency protection, ethical investment and so on.

The second and third categories may be the most difficult for manufacturers to specify for many products. It is not clear how someone could be a first time investor, as they will have no experience and, likely, very little knowledge. ESMA does note that “the simpler the product is, the less detailed a category may be” and a new example is given for non-complex UCITS. However, specifying the numerical percentage of losses that can be borne or maximum percentage of assets that should be invested in the product will be difficult.

ESMA makes clear that manufacturers need to identify the potential target market (TM) using their theoretical knowledge and experience of the product, whereas distributors must identify the actual TM using information from manufacturers, knowledge of their client bases and taking into account the nature of the service they provide. This process is separate to the suitability and appropriateness requirements. The distribution strategy of both manufacturers and distributors should be consistent with the product’s TM.

Firms must also consider whether the product has a “negative” TM, sales within which should be rare. Distributors must document and substantiate these decisions and, if relevant to the product governance process, report them to the manufacturer.

The guidelines describe how the requirements apply in relation to professional investors and eligible counterparties, and to products manufactured by entities not subject to MiFID II (eg UCITS managers, AIFMs and third country firms). There is a new section on portfolio management, which recognises that a diversified portfolio will include a number of products with differing individual risk and return profiles. ESMA accepts that products can be sold outside their TMs where the portfolio as a whole, or the combination of a financial instrument with its hedge, is suitable for the client.

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