On 5 March 2015, the UK’s Financial Conduct Authority (“FCA”) published a thematic review on product development and governance in relation to structured products.1
The FCA states that its review is part of its ongoing examination of how firms in retail and wholesale markets are developing new structured products in the light of the finalised guidance for structured products published by the Financial Services Authority (“FSA”), the FCA’s predecessor, in March 2012.2 The review focuses in particular on the FCA’s objective that firms treat their customers fairly and have appropriate arrangements and safeguards in place in relation to product development and governance, to enable them to meet their requirements in this regard. The FCA stresses, in particular, that firms should:
- identify the target market and design products that meet the needs of end customers in that target market;
- stress-test new products to ensure they are capable of delivering fair outcomes for the target market of end customers;
- have a robust product approval process for new products;
- provide appropriate information to distributors and end customers; and
- monitor the progress of a product through to the end of its life cycle.
The FCA’s review included research relating to retail customers buying structured products, looking at whether they were making informed product choices. It also engaged in detailed supervisory assessments with a number of retail and wholesale firms involved in manufacture and distribution. The FCA concluded that retail customers continue to struggle to understand complex features common to many structured products and often overestimate their potential returns. It also concluded that many firms manufacturing and distributing structured products are not sufficiently following the previous FSA guidance and, in particular, (a) are not defining a clear target market at the product design stage, (b) are not conducting sufficiently robust analysis and stress testing and (c) are not properly assessing whether products are likely to represent value for money for end customers. In addition, the FCA is concerned that some manufacturers are failing to monitor how products are distributed and whether distributors have sufficient information about the product and the target market to meet their own obligations to the end customer.
The FCA specifies six key messages arising out of its work:
- retail customers generally struggle to understand the relative merits of structured products and the factors driving potential returns. Firms should take steps to bridge this knowledge gap;
- firms’ senior management must do more to put customers at the forefront of their approach to product governance
- this should begin with the identification of a clear target market during product design;
- structured products should have a reasonable prospect of delivering economic value to customers in the target market. Firms should use stress testing as part of the product approval process to help meet this objective;
- firms should provide customers with clear and balanced information on each product and any risks;
- manufacturers should strengthen the monitoring of their products, including ensuring distributors have enough information about the product to sell it appropriately and checking that each product is being distributed to its target market;
- firms should do more to ensure fair treatment of customers throughout the lifecycle of a structured product.
The FCA’s focus on product development and governance is consistent with an increased EU regulatory focus in this area under the recast Markets in Financial Instruments Directive (“MiFID II”) and the Regulation relating to Packaged Retail and Insurance-based Investment Products (“PRIIPs”). The FCA notes that these regulations will impose more detailed requirements on firms manufacturing and distributing structured products to retail customers. The FCA states that all the firms it assessed as part of the thematic review will be asked to explain how they will ensure the fair treatment of customers for the new structured products they bring to market. This may include remediation work by some firms and could lead to redress for some customers. The FCA also indicates that if necessary, it will consider the use of other regulatory tools, including by using its product intervention powers.