The EBA published a consultation paper on 10 November 2014 recommending good practice guidelines for both manufacturers and distributors of retail banking products. For manufacturers, the requirements cover internal control functions, target market identification, product testing, disclosure, product monitoring, remedial actions and the selection of distribution channels. The requirements for distributors cover their internal arrangements, identification and knowledge of the target market, and information requirements. Comments may be submitted until 10 February 2015.1
Relevant definitions and conditions are:
‘Target market’ means the group or groups of end consumers for whom the product is designed, as defined by the manufacturer.
‘Product’ means, for purposes of the consultation paper:
‘credit agreements relating to immovable property’ as defined in Article 4(3) Mortgage Credit Directive (MCD);
Please see also our 23 May 2014 Compliance Alert on ESMA’s opinion on structured retail products.
‘deposits’ as defined in Article 2(3) of Directive 2014/49/EU (“Deposit Guarantee Scheme Directive, DGSD”);2
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Where the manufacturing and/or distribution of a product is in whole or in part outsourced to third parties, or is carried out by another entity in other ways, manufacturers and, where applicable, distributors should ensure that they comply with the requirements established in the Committee of European Banking Supervisors (CEBS) Guidelines on outsourcing.4 This includes, in particular, Guideline 2, which provides that “the ultimate responsibility for the proper management of the risks associated with outsourcing or the outsourced activities lies with an outsourcing institution’s senior management.”
Developments in the markets for financial services in recent years have shown that the misconduct of financial institutions with respect to their retail customers can not only cause significant consumer detriment, but also undermine market confidence, financial stability and the integrity of the financial system. It can also generate direct costs to financial institutions as a result, for example, of fines and penalties imposed through regulatory proceedings, settlements with regulators, sums paid as redress or compensation to third parties as required by regulators or the courts and loss of income.
In order to address some of the causes of conduct failure and to complete the initial work carried out by the Joint Committee of the three European Supervisory Authorities (phase 1), the EBA has developed detailed guidelines for product oversight and governance (POG) with regard to retail banking products and services that fall within its regulatory remit, i.e., mortgages,
Deposits include all forms of deposits, including ‘structured deposits’ as defined in point (43) of the Markets for Financial Instruments Directive 2014/65/EU (MiFID 2). Financial institutions issuing them are subject to the Capital Requirements Directive (CRD IV) and the Deposit Guarantee Scheme Directive (DGSD). In addition, the Commission is currently developing delegated acts under Art 16(3) and (12), in line with Article 1(4) of MiFID2, on specific aspects of the selling and advising of structured deposits. The European Banking Authority (EBA) will monitor the development of the Commission’s delegated acts, so as to ensure the respective requirements are clearly expressed and delineated in the final EBA Guidelines. See also definition in article 4 of the consultation paper on the draft RTS on the specification of the assessment methodology for competent authorities regarding compliance of an institution with the requirements to use the IRB Approach in accordance with Articles 144(2), 173(3) and 180(3)(b) of Regulation (EU) No 575/2013, published on 12 November 2014. See CEBS (2006), Guidelines on Outsourcing.
personal loans, credit/debit cards, savings products, payment services and current accounts (phase 2).
The guidelines require the establishment of internal arrangements for the design, marketing and life cycle maintenance of products and are aimed at ensuring that products are designed to meet the interests, objectives and characteristics of the target market.
The guidelines apply to both manufacturers and distributors of retail banking products. The requirements for manufacturers cover the manufacturer’s internal control functions, identification of the target market, product testing, disclosure, product monitoring, remedial actions, and the selection of distribution channels. The requirements for distributors, in turn, cover the distributor’s internal arrangements, identification and knowledge of the target market, and information requirements.
Developing products with the consumer’s interest, objectives and characteristics in mind from the outset is a cornerstone of ensuring good consumer outcomes, helping to re-establish and maintain confidence in retail banks. The guidelines do not simply address past failings but also provide a framework for robust and responsible product design and distribution to help avoid future conduct failure.
Conduct failure occurs in many ways, but the types of failure may be usefully grouped together as:
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Regulators wish not only to protect consumers, but also to promote market confidence, financial stability and the integrity of the financial system in their national jurisdictions and at the European level.
Financial institutions that manufacture products should implement internal arrangements for the design, marketing and life-cycle maintenance of products. These arrangements should ensure that products are designed, in principle, to meet the interests, objectives and characteristics of a certain type of consumer (the target market), while taking into account factors such as the financial capability of the target market, cost effectiveness and the financial efficacy of the product. The arrangements should also identify any need to modify/replace existing products when they no longer meet the interests, characteristics or objectives of the target market for which the product was conceived.
Subsequently, manufacturers should periodically assess: (i) compliance with the internal product oversight and governance arrangements; (ii) the continued validity and currency of internal product governance and oversight arrangements; and (iii) the degree to which
particular products continue to meet the interests, objectives and characteristics of the target market for which they were designed.
Distributors of retail banking products should comply with the product oversight and governance arrangements of the manufacturer that are specific to their role of bringing products to the market. Distributors should know and recognize the target market for which the product was designed and should normally only sell and offer the product to end consumers in that target market. When providing advice to a consumer, distributors may sell products outside the target market defined by the manufacturer, provided they justify such decision in the durable medium stating the advice given.
Manufacturer product oversight and governance arrangements for retail banking products
Establishment, proportionality, review and documentation
The arrangements should be designed to minimize potential consumer detriment, avoid potential conflicts of interest, and ensure that the interests, objectives and characteristics of consumers are appropriately taken into account.
The arrangements should be reviewed and updated on a regular basis.
A new product approval policy (NPAP) should be established.
All actions taken by the manufacturer in relation to the product oversight and governance arrangements should be duly documented, and the documentation should be kept by the manufacturer for audit purposes and made available to the competent authorities upon request.
All arrangements and actions should be proportionate to the level of complexity of the product as well as nature, scale and complexity of the relevant business of the manufacturer.
Manufacturer’s internal control functions
POG is an integral part of its governance, risk management and internal control framework.
Senior management, with support from representatives of the manufacturer’s compliance and risk management functions, should ensure continued internal compliance with the POG arrangements. They should periodically review the POG to ensure that it is appropriate and current and propose amendments to the management body when this is no longer the case.
The Risk Control function and the Compliance function should make review of POG an integral part of their normal duties.
Senior management should ensure that staff involved in designing a product are familiar with and follow the manufacturer’s product oversight and governance arrangements.
The target market(s) of a product should be identified.
The product should be appropriate for the interests, objectives and characteristics of the identified target market(s).
Only products with features, charges, risks, that meet the interests, objectives and characteristics of, and are of benefit to, the particular target market identified for the product should be designed and brought to market.
The product should fit within the manufacturer’s existing product range, and the manufacturer should avoid producing too many product variants if that would prevent the consumer from making informed decisions.
Products should not be offered in market segments in which they are not likely to satisfy the interests, objectives and characteristics of the relevant consumers.
When deciding whether or not a product meets the interests, objectives and characteristics of a particular target market, the manufacturer should assess the degree to which the target market is financially capable.
Before a product is designed and brought to the market, an existing product is sold to new target markets, or significant changes are made to an existing product, the manufacturer should conduct product testing to assess how the product would affect its consumers under a wide range of scenarios, including stressed scenarios. Manufacturers should make appropriate product changes if the scenario analysis indicates poor results for the target market.
Product testing should also ensure that information provided by manufacturers to distributors and the target market is understandable to the end-user.
5.1. Once a product is brought to market, the manufacturer should monitor its performance on an ongoing basis to ensure that the product continues to meet the interests, objectives and characteristics of the target market.
If the manufacturer identifies a problem related to one of its products in the market, it should take the necessary action to mitigate the situation and prevent a recurrence of detriment.
The remedial action should include promptly notifying the distributor of changes or modifications to the existing product and any additional actions that need to be taken to remedy the situation.
Remedial action relating to product oversight and governance is without prejudice to remedies given to individual consumers.
Selection of distribution channels
Distribution channels should be chosen that are appropriate for the particular target market. To that end, the manufacturer should select distributors that have the appropriate knowledge, expertise and capability correctly to place each product in the market and to provide appropriate information to the target market. When selecting its distribution channels, the manufacturer may consider limiting the distribution of a specific product to channels that offer specific features to consumers.
Products should be distributed only to the identified target market except on a justified and infrequent basis.
All reasonable steps should be taken to ensure that distributors act in compliance with the objectives of the manufacturer’s product oversight and governance arrangements. The manufacturer should take appropriate action when concerns about the appropriateness of the distribution channel are raised, for example by ceasing to use that channel for a particular product.
Where different business units of the manufacturer are involved in the design and distribution of the product, the manufacturer should require the staff in charge of designing the product to communicate to the staff in charge of distributing the product the relevant information needed to: (i) place the product appropriately in the market; (ii) identify the target market for each product; (iii) determine when the product no longer meets the interests, objectives and characteristics of the target market; and (iv) take the appropriate action to remedy the situation.
Information for distributors
Where relevant, the manufacturer should provide the distributor with a description of the main characteristics of the product, its risks and limitations, and the total cost of the product to be borne by the consumer, including all related fees, charges, and expenses.
The information and details of the products to be provided to distributors should be adequate, clear, precise and up-to-date.
Information given to the distributors should include all relevant details to enable them to:
Understand and place the product properly on the market;
Recognize the target market for which the product is designed, and also to recognize market segments whose objectives, interests and characteristics are unlikely to be met; and
Meet any other obligations under already applicable European legislation.
Distributor guidelines regarding product oversight and governance arrangements for retail banking products
Establishment, proportionality, review and documentation
Effective product oversight and governance arrangements that are specific and proportionate to the distributor’s size and to its role in bringing products to the market should be implemented and reviewed. The arrangements should be designed to minimize potential consumer detriment and avoid potential conflicts of interest.
The product oversight and governance arrangements should be reviewed and updated on a regular basis.
All actions taken by the distributor in relation to the product oversight and governance arrangements should be duly documented, and the documentation should be kept for audit purposes and made available to the competent authority, or the manufacturer, upon request.
Internal control functions
Product oversight and governance arrangements should be an integral part of the general systems and controls within the distributor. To that end, the distributor’s management body, if relevant, should endorse their establishment and subsequent reviews.
Knowledge of the target market
The information provided by the manufacturer should be used and the knowledge and ability to determine whether a consumer belongs to the target market should be developed. The distributor should particularly take due account of all relevant information allowing it to recognize the target market for which the product is designed, and also to recognize market segments for which the product is unlikely to meet the interests, objectives and characteristics of that market.
Disclosures provided by the manufacturer should be taken into account; the target market should be given a description of the main characteristics of the product, its risks, the total cost to be borne by the consumer, including all related fees, charges,
and expenses, and any additional material supplied by the manufacturer. These arrangements are without prejudice to any requirements that may be imposed on distributors by existing and/or forthcoming EU and national legislation on disclosure regimes relating to specific products or services.
Information should be retained to justify to the manufacturer why a product was offered to a consumer who does not belong to the target market.
In order to assist manufacturers in their obligation to monitor their products, the distributor should collect, on a continuous basis, information that documents whether the product meets the interests, objectives and characteristics of the target market.
If the distributor identifies any problems regarding product features, product information or the target market, it should promptly inform the manufacturer.
This remedial action by the distributor is without prejudice to any relief given to individual consumers.
For their product oversight, the EBA appears to be following the same approach as ESMA did in connection with its 27 March 2014 opinion on structured retail products:
Define target markets;
Implement product governance structures; and
Cover manufacturers as well as distributors.