13 January 2017 – As of 3 January 2018, distributors of investment products will be required to define a target market for each of the products they include in their product assortment and intend to recommend to their clients. This target market should describe for whom a particular product is intended.
In principle, European Investors is very supportive of the new product governance rules introduced by MiFID II, of which the target market assessment is an essential part. Firms that recommend investment products to retail clients should have a thorough understanding of the risks inherent to these products and think carefully about which clients’ needs they might serve (and which they do not). European Investors is however concerned about the way the obligation to perform a target market assessment is given shape by the ESMA draft guidelines of October 2016.
According to European Investors, the final decision to recommend a product or not, should be based on an assessment of suitability. Such an assessment looks at the individual characteristics, objectives and needs of the client that is serviced. The target market assessment should help the firm to perform this assessment more effectively, but it should not supersede it in any way. The draft guidelines, seem to suggest otherwise. Although it is stated that individual facts might allow firms to recommend products outside of the target market, the draft guidelines stipulate that deviations “should not occur on a regular basis”.
The possibility to deviate from the target market is especially warranted since the focus of the target market assessment is the individual product. An appropriate advice, however, looks at the individual client’s portfolio as a whole. It makes a hugh difference whether a product is recommended to make out a limited percentage of the client’s portfolio, or as one of its major building blocks. Also, there might be strong positive (or negative) correlations between the volatility of different products which make a portfolio more (or less) riskier as its individual parts suggest.
Manufacturer versus distributor
A second concern European Investors has, relates to potential erosion of responsibility (and liability) of the distributor. The draft guidelines prescribe that the manufacturer is required to perform a target market assessment that should set the boundaries for the more granular target market that is identified by the distributor. Also, the manufacturer should define a highly detailed distribution strategy, suggesting amongst others whether a product should be sold with or without advice.
It is however the distributor who should know best for whom of its clients a product is suitable (and for whom not) and about the extent to which its clients need guidance. It is therefore important to European Investors that, when misselling occurs, the distributor is not in the position to safeguard itself from liability by referring to the manufacturer’s target market or proposed distribution strategy. The distributor should carry full responsibility for its actions vis-à-vis his clients, unless the manufacturer has provided misleading or omitted product information.
European Investors expressed its concerns to ESMA through its response to the consultation that was held on the draft guidelines which closed on 5 January 2017.