MiFID2/MiFIR: what, when, who and how? Product governance

This article sets out a summary for clients of the key issues to consider in relation to the product governance regime under MiFID2.

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What does MiFID currently do?

Are these provisions currently in MiFID?


What are the key differences between the current regime and MiFID2?

MiFID2 introduces a new regime in relation to a firm’s product governance arrangements and the manufacture and distribution of products and services (including funds and related management services) to end clients. These changes include:

  • Requirement to have explicit product governance arrangements in relation to the manufacture and distribution of products and services.
  • Requirement for product manufacturers to maintain a product approval process for each financial instrument, which identifies the target market for each product and ensures that all relevant risks to that target market are assessed and that the intended distribution strategy is consistent with the identified target market.
  • Requirement to review products regularly to assess whether the product remains consistent with the needs of the identified target market.
  • Requirement to provide the distributor with all appropriate product information, including the identified target market of the product.
  • Requirement that a firm who offers or recommends a product understand the features of the product, including the identified target market, and
  • The MiFID2 product governance provisions will apply to MiFID investment firms which manufacture and distribute products and/or offer services to clients, and have wide ranging implications.

The MiFID2 product governance provisions are not directly applicable to EU AIFMs and UCITS management companies when carrying out the activities of managing (or marketing) an AIF for which they act as an AIFM or a UCITS for which they act as the UCITS manager. However, the product governance requirements are intended to apply to investment firms authorised under MiFID2 and the provisions are equally applicable to other supervised entities subject to MiFID2 such as AIFMS and UCITS management companies to the extent that they perform MiFID investment services in respect of portfolio management and investment advisory services. ESMA has specifically amended the technical advice to clarify the information which distributors will need to obtain in such cases as noted below.

What is MiFID2 going to do?

What does Level 1 say?

Directive 2014/65/EU: Art. 16(3) and Art 24

Art 16(3)

  • An investment firm which manufactures financial instruments for sale to clients must maintain, operate and review a process for the approval of each financial instrument and significant adaptations of existing financial instruments before it is marketed or distributed to clients.
  • The product approval process must specify an identified target market of end clients within the relevant category of clients for each financial instrument and must ensure that all relevant risks to such identified target market are assessed and that the intended distribution strategy is consistent with the identified target market.

An investment firm must also regularly review financial instruments it offers or markets, taking into account any event that:

  • could materially affect the potential risk to the identified target market, to assess at least whether the financial instrument remains consistent with the needs of the identified target market and whether the intended distribution strategy remains appropriate.
  • An investment firm which manufactures financial instruments must make available to any distributor all appropriate information on the financial instrument and the product approval process, including the identified target market of the financial instrument.
  • Where an investment firm offers or recommends financial instruments which it does not manufacture, it must have in place adequate arrangements to understand the characteristics and identified target market of each financial instrument.

Art 24

  • Investment firms which manufacture financial instruments for sale to clients must ensure that those financial instruments are designed to meet the needs of an identified target market of end clients within the relevant category of clients, the strategy for distribution of the financial instruments is compatible with the identified target market, and the investment firm takes reasonable steps to ensure that the financial instrument is distributed to the identified target market.

An investment firm must understand the financial instruments they offer or recommend, assess the compatibility of the financial instruments with the needs of the clients to whom it provides investment services, also taking account of the identified target market of end clients as referred to in Article 16(3), and ensure that financial instruments are offered or recommended only when this is in the interest of the client.

What does Level 2 say?

Phase 1 (May 2014 to Aug 2014):

ESMA Consultation Paper CP 2014/549 (CP1)
ESMA considers that:

  • the MiFID Implementing Directive should be amended by adding new provisions aimed at specifying how investment firms manufacturing and/or distributing investment products should organize themselves in order to reduce, from an early stage, potential risks of misselling.
  • product governance arrangements should be considered broadly, meaning that they should also apply, where relevant, to the provision of investment services, and
  • the measures are to be applied in an appropriate and proportionate manner, in line with the MiFID proportionality principle, to different national legal and economic models.

ESMA proposes the introduction of two sets of policy proposals for product governance arrangements for:

  • investment firms to adopt when manufacturing products, and/or
  • investment firms to adopt when deciding the range of products and services they intend to offer to clients.

Phase 2 (Dec 2014 to March 2015):

Final Report 2014/1569

  • Scope of the term "manufacturer" (considering in particular, the absence of definition in MiFID2 and the use of such term in PRIIPs) and "distributor" - Article 16(3) sub-paragraph 2 takes an intentionally broad approach to ‘manufacturers’ which aims at ensuring that the requirements apply to a large scope of firms and situations:
    • Investment firms that "create, develop, issue and/or design in-vestment products" should be considered as “manufacturers”. "Distributor" refers to an investment firm that offers and/or recommends investment product and services to clients. In this context, ‘offers’ has a wide application and is to be read in a broad sense.
    • Where investment firms "create, develop, issue and/or design investment products" to be launched on the primary market, the product governance rules for manufacturers apply. Where this firm is also involved in the distribution of such products, these product governance rules for manufacturers should apply in addition to the rules which would apply to them as distributors. Where such investment products are then distributed by other investment firms to clients, eg through placements or on the secondary market, the product governance obligations for distributors apply.
  • Respective responsibilities of the manufacturer and the distributor in the definition of the ‘target market’ and clarification of the level of granularity expected from manufacturers when identifying the "target market":
    • Inappropriate to specify in too much detail the level of granularity that is required, since this will vary according to the specific circumstances. For simpler, more mainstream investments, such as ordinary shares, it is likely that the target market will be identified with less detail. For more complicated, less mainstream investments, such as contingent convertible securities or structured products with complicated return profiles, the target market should be identified with more detail.
    • The criteria used to define the target market and determine the appropriate distribution strategy must be relevant for the product. These criteria must make it possible to assess which clients fall within the target market, for example to assist in ongoing product reviews after the product is launched. The analysis of the target market for the purposes of product governance arrangements is distinct from and does not replace the suitability/appropriateness assessments which are conduct of business rules that take place for each specific transaction concluded by a given investor in relation to a given product.
  • MiFID2 requires investment firms which manufacture financial instruments to assess whether the distribution strategy is consistent with the target market. ESMA has also clarified in the technical advice that distributors need to assess whether the distribution strategy is consistent with the identified target market. Going forward ESMA considers that there may be scope for future Level 3 work to assess target market criteria.
  • Product governance requirements set out in MiFID2 are intended to apply to investment firms authorised under MiFID2 and to other supervised entities subject to MiFID, such as UCITS management companies and alternative investment fund managers, only when such entities are authorised to perform MiFID investment services. In addition, the European Commission should consider aligning the relevant UCITS and AIFMD articles with the product governance obligations for manufacturers.
  • Application of the requirements to both the primary market and the secondary market - product governance rules should apply irrespective of the type of service provided and of the requirements applicable at point of sale. Where investment firms provide execution-only brokerage platforms they will be subject to the distributor product governance obligations. In such cases when having to identify a target market, they will, having considered the information provided by the manufacturer, and, as explained above, identify the target market taking into account the product and the investment service through which the client can invest in the product. For more “plain vanilla” products this process will be relatively simple given that many of these products can be compatible with the needs and characteristics of the mass retail market. The product can be distributed to this market without need to further refine the target market. For complex products, the distributor would be expected to consider the existing appropriateness information they possess about their clients in identifying the target market.
  • Both the manufacturer (when applicable) and the distributor requirements should apply with respect to shares and bonds.
  • Distributors to periodically inform the manufacturer about their experience with the product - This does not mean that distributors need to report every sale to manufacturers, or that manufacturers must confirm that each transaction was distributed to the correct target market. Relevant information could include, for example, information about the amount of sales made outside the target market, summary information of the types of client, a summary of any complaints received or by posing questions suggested by the manufacturer to a sample of clients for feedback. The obligation is for distributors to provide the data that is necessary for the manufacturer to be able to review the product and check that it remains consistent with the needs, characteristics and objectives of the target market as defined by the manufacturer itself. It should be possible for the distributor to use the scenario analysis of products conducted by manufacturers in order to comply with their obligation to provide fair clear and not misleading information to clients.
  • Firms should take "appropriate action" where they become aware of an event that could potentially affect the risk of the identified target market but that there should be no predetermined action to be taken in all cases.
  • It is possible that some products may be distributed to clients outside the manufacturer’s target market. Distributors remain responsible for meeting the required standards for distribution and it may be that such sales remain suitable/ appropriate. However, if a manufacturer observes a trend (across the market or at specific distributors) for sales outside the target market, they may wish to consider if it is necessary to take action. It may be that the original target market is too narrow, for example, or this could be an indication of problems with the product or the way in which it is being distributed, requiring additional action.

Will any Member States be gold plating?

  • In the UK, the FCA has already sought to highlight the need for firms to take responsibility for the design of their products, and how they are sold, but MiFID2 will see the FCA codifying these expectations into rules. Please see the FCA Responsibilities of Providers and Distributors for the Fair Treatment of Customers (RPPD) and FCA Retail Product Development and Governance – Structured Product Review – Finalised Guidance (March 2012). The RPPD and the March 2012 guidance apply to UK regulated firms involved in the supply of products or services to retail customers.
  • In addition, ESMA developed a broad set of non-exhaustive examples of good practices that focus on structured products and illustrating arrangements that firms - taking into account the nature, scale and complexity of their business - could put in place to improve their ability to deliver on investor protection regarding, in particular, (i) the complexity of the structured retail products they manufacture or distribute, (ii) the nature and range of the investment services and activities undertaken in the course of that business, and (iii) the type of investors they target. ESMA considers these good practices will bridge the gap until the MiFID2 product governance requirements are further developed and in place.
  • Key differences to the UK position adopted in MiFID2 are:
    • the application of the provisions where the end client is a professional client
    • the codification into rules rather than guidance, and
    • the range of products and services caught.

When will it happen?

When will these provisions apply?

Member States are required to adopt and publish measures transposing MiFID2 and delegated acts into national law by 03 July 2016. MiFID2 and delegated acts under MiFID2 will apply from 03 January 2017.

What happens next?

ESMA delivered its final technical advice for delegated acts on the 19 December 2014 to the European Commission in the FR. The European Commission must adopt the delegated acts within 6 months which will then be published in the Official Journal. The European Parliament and Council have the right to object to a delegated act within three months (which can be extended by a further three months).

The deadline for responses to CP2 was 02 March 2015. ESMA will then update the draft technical standards and send its final report to the European Commission.

How is it going to impact my business?

Who will be affected by these changes and how will it impact their business?


  • Manufacturers should have procedures and measures in place to ensure design of product does not adversely affect the end client or cause problems with market integrity.
  • Management body to have effective control over product governance process.
  • Identify target market on a theoretical basis, analyse why the product is compatible with the target market and determine investors for whom the product would not be compatible.
  • Carry out scenario analyses which test the risk of poor investment outcome and circumstances which may cause such outcome.
  • Consideration of charging structure given characteristics of target market
  • Product review for any re-launch or further issue to ensure remains compatible with objectives, needs and characteristics of target market.
  • Identify and take action if event occurs that affects the potential risk and return expectations.
  • Amendments to distribution agreements likely to be required.
  • Likely use of due diligence questionnaires with relevant counterparties.


  • Distributors should use the manufacturer’s more general target market assessment together with existing information on their clients to identify their own target market for a product.
  • Ensure they have in place adequate product governance arrangements to ensure product and services they intend to offer are compatible with the client. Arrangements should also comply with other COB rules (conflicts, suitability, inducements etc).
  • Ensure that management body endorses the range of investment products and services that will be offered and the respective target markets. Compliance must oversee the development and review of the product governance arrangements.
  • Provide manufacturer with sales information to ensure manufacturers can carry out product reviews.
  • Consideration of charging structure given characteristics of target market
  • Periodically review and update product governance arrangements to ensure they remain fit for purpose and robust.
  • The technical advice in the Final Report provides that when investment products are manufactured by non-MiFID firms including AIFMs and UCITS management companies, distributors must take all reasonable steps to ensure that the level of product information obtained from the manufacturer is of a reliable and adequate standard to ensure that products will be distributed in accordance with the characteristics, objectives and needs of the target market. The Final Report suggests that where material information is not publicly available, the reasonable steps required of the distributor will include entering into an agreement with the manufacturer or its agent to provide all relevant information.

Firms will need to manage the allocation of responsibility between manufacturers and distributors and ensure that arrangements are in place to exchange the necessary information. This will be particularly important where the manufacturer or distributor is a non-MiFID or third country firm.

Action for firms?

Q1 2015

  • Consider implications of ESMA’s FR published December 2014 and responses published March 2015.

Q2-Q4 2015

  • Review current practices and procedures within the business and perform impact analysis to determine changes required to business practices and procedures. Identify which services are currently being received on a bundled basis and will need to be unbundled when MiFID2 is implemented.
  • Consider the options for how investment research will be paid for following the implementation of MiFID2 (ie absorbed as a cost of the business, offset by higher management fees or through separate research payment accounts) and relevant changes to documentation or additional contractual documentation and procedures required.


  • Prepare required internal documentation and/or amend existing documentation (compliance manual, conflict of interest policy, customer documentation) in line with new requirements.
  • Discuss with sell side counterparties how the unbundling of research and other value add services will affect commission rates/transaction spreads and put revised commission arrangements in place.
  • Provide training to staff to ensue they are aware of the revised compliance arrangements, contractual relationship with brokers and internal processes and procedures.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.