What is product governance?

Product governance refers to the systems and controls that firms must have in place to design, approve, market and manage products through their lifecycle to ensure that they meet legal and regulatory requirements.

Good product governance should result in products that:

  • meet the needs of one or more identifiable target market
  • are sold to clients in the target markets by appropriate distribution channels, and
  • deliver appropriate consumer outcomes.

The regime in relation to product governance under MiFID II seeks to implement product related requirements and processes that establish a benchmark for financial instruments and distribution.

What is the scope of MiFID II?


The regime applies to financial instruments and structured deposits.


From a UK perspective, those who are required to follow the regime are firms engaged in MiFID business. It is important to note that non-MiFID business firms which manufacture or distribute MiFID products (e.g. certain UCITS management companies or AIFMs), although they are not obliged to implement the rules, should treat them as guidance.

Why have product governance requirements been introduced under MiFID II?

MiFID II introduces an EU wide product governance regime applying along the distribution chain from product manufacturers to product distributors.

The UK already has a framework in place based on FCA guidelines; the introduction of the MiFID II regime will reinforce these obligations. The objective behind MiFID II is to institutionalise systems and controls which reduce the risk of mis-selling of investment products. It seeks to better protect investors by regulating each stage of a product’s life cycle (design, distribution, point of sale and product reviews).

The emphasis in MiFID II is on clearly expressing the regulatory roles and responsibilities of the manufacturer and those in the distribution chain with a focus on good outcomes for the investor. This sharing of roles and responsibilities will re-shape the contractual relationship between manufacturers and distributors as it will not be possible for manufacturers to contract out of their obligations under MiFID II. Key responsibilities on manufacturers Manufacturers are the firms that create, develop, issue or design investment products. They are required to:

Undertake a product approval process to ensure the product meets the need of the identified target market

This process must be undertaken before marketing or distribution for each financial instrument and for significant adaptations of financial instruments. It must include policies and procedures to ensure that the product complies with all applicable rules.

To ensure that the needs of the target market are met manufacturers should consider the characteristics of a product including complexity, risk reward profile, liquidity and, if relevant, the innovative nature of the product.

Ensure that the intended distribution strategy is consistent with the identified target market

Products can only be manufactured and distributed when they meet the needs of the target market, all risks to the end customer must be assessed. For example, if a manufacturer is designing a complex product, it should ensure that it is only sold if advice has been given to the end customer.

Ensure that the product or service reaches the target market

This requirement is underpinned by the need to ensure effective information flows back and forth along the distribution chain so that the manufacturer can assess the effectiveness of the distribution strategy.

Periodically review the product, the target market and the distribution channel to ensure they remain appropriate

It is important to note that this regime does not cease to be relevant once the product is launched. Periodic reviews are a key part of the product governance regime.

Ensure distributors understand the approved process, the target market and the distribution channel to ensure they remain appropriate

This is an important requirement. It must be noted that it imposes an onerous obligation on manufacturers, particularly with more complex products.

Ensure that the management body has effective control

ESMA particularly concentrates on this requirement. There must be effective management at board level and through the firm’s compliance function.

What if one of these requirements is not fulfilled?

If a problem is identified by the manufacturer there are a number of steps it can take to remedy the problem including terminating the distribution arrangement, liaising with the distributor to monitor the distribution process and, in extreme cases, notifying the FCA if there is a problem and setting out to them how they plan to address it.

Key responsibilities on distributors

The definition of a distributor is very wide, it is a firm that offers, recommends, or sells investment products or provides investment services to clients. They are required to:

  • Consider which target market is likely to be suitable and any types of investors for which it may not be suitable (before distribution of the product) - A distributor must review the manufacturer’s distribution strategy with a critical eye in light of the distributor’s particular client base and the particular services that the distributor provides to ensure the products are suitable for that client. It is important for them to note that, just because a manufacturer has determined a particular distribution strategy, this does not mean that the distributor cannot take a different approach.
  • Ensure that they obtain relevant information regarding products they offer or distribute from the manufacturers - This includes information on the financial instrument, the product approval process, details of the target market assessment and the appropriate distribution channels.
  • Ensure that products are distributed to the proper target market and carry out reviews to make sure that this is the case - The distributor will, in many cases, have the necessary information about clients to ensure they fall within the proper target market or, if they do not, that there are good reasons why distribution is still appropriate.
  • Assess the compatibility of the financial instruments with the needs of the clients to whom investment services are offered - As above, the distributor will have the necessary information to assess this.
  • Provide information to manufacturers about product sales - The information which must be provided is the proportion of sales made outside the target market, summary information on types of client, summary of complaints received, answers to sample questions designed by the manufacturer to obtain valuable feedback and details of circumstances when a distributor has wrongly identified a target market.
  • Ensure that the management body has effective control - There must be effective management at board level and through the firm’s compliance function.

How to identify target markets

ESMA has set out guidelines to assist firms (both manufacturers and distributors) to assess and identify target market for their products. ESMA advises firms to consider the types of client to whom the product is marketed.

To do so they should look at the clients’:

Knowledge and experience

Firms need to identify which knowledge the clients have about product type and features. They also need to identify how much experience they have in this area as knowledge can compensate for lack of experience.

Financial situation (ability to bear losses)

The firm should specify the level of losses that a client is able and willing to afford. Risk tolerance and compatibility of risk/reward profile with the target market. Clients’ basic risk attitudes should be categorised and clearly defined. If applicable, firms should use the risk indicator stipulated by the PRIPS regulations.

Objectives and needs

Objectives are the clients’ wider goals e.g. liquidity supply or retirement provision. Needs can be more specific e.g. relevant to their country of tax residence.

These are the minimum categories to consider and categories should be added if, in the manufacturers view, they are important to describe the product.

Manufacturers will base their assessment on a theoretical group of clients and the past experience of the manufacturers. Distributers should identify their target market on a more precise basis using information they receive from the manufacturer.

Identification should be carried out in an appropriate and proportionate manner taking into account the nature, scale and complexity of a firm’s business and the nature and range of Financial Services. It should be “sufficiently granular.”

What are the key differences between MiFID II Product Governance and current FCA Guidance?

  • The requirement to identify the target market at “a sufficiently granular level”
  • responsibility for process attaching to the holder of the compliance function oversight
  • enhanced information flows
  • wide ranging conflicts of interest provisions
  • more intensive product reviews
  • impact on the roles, and
  • responsibilities along the distribution chain.

The inter-relationship between product governance and suitability and appropriateness

It is critical to note that product governance is not a substitute for suitability and appropriateness assessments carried out by a firm in the provision of investment services to each client.

Suitability and appropriateness obligations are clearly much more granular and focus on specific clients and their circumstances. The application of suitability and appropriateness may, on occasion, produce a different answer to a target market analysis.

Product governance sits alongside and above the core suitability and appropriateness tests and provides a framework of high level strategic suitability which aids the facilitation of such tests.

What is the impact of the product governance regime on “execution only” services?

  • Where execution only dealing is in a complex product and an appropriateness assessment is required, firms will be expected to obtain more detailed, granular information. Whereas, standard products can be distributed with generic, less detailed information.
  • Where an appropriate assessment is not required, the firm’s role is likely to be more about communicating the target market to the investor rather than imposing any additional point of sale requirements.

What is the impact of the product governance regime on the concept of complex and non-complex products?

In the product governance regime, the regulator’s perception of what constitutes a “complex product” is key. Due to the proportionality approach taken in product governance, there is a more intense application of the rules to complex products and a less intense application for non-complex products.

Under MiFID II, significantly more products are regarded as complex for the purpose of the appropriateness rules. Examples:

  • Shares that are admitted to trading on a regulated market or MTF are complex if they embed a derivative
  • Bonds that are admitted to trading on a regulated market or MTF are complex if they embed a derivative or are structured in a way that makes it difficult for clients to understand the risks involved
  • Structured UCITs

There is also an ongoing debate as to whether or not proposals to include NURS and Investment Trusts are complex will be implemented.