Product Governance: Paternalism Outsourced to Financial Institutions?

Abstract

High ranking in the top ten of challenges for the financial sector in 2018 was the entry into force of the second version of the Markets in Financial Instruments Directive (MiFID II). Among the most striking novelties in MiFID II are without doubt the product governance rules, which to this day cause a lot of interpretation and implementation difficulties. They introduce a kind of “know-your-customer” requirements at product level: both in the design and the distribution phase of a product, the target market for that product is to be identified. As a result product manufacturers and distributors need to properly understand all product features and assess for what type of clients those products could be suited. Those product governance rules should prevent that products are sold or recommended to investors for whom they are not intended and come on top of pre-existing measures, such as the suitability and appropriateness assessments. Although the aim of the product governance rules is commendable, the new regime is far from perfect. After briefly describing the MiFID II rules on product governance for product manufacturers and product distributors, this contribution discusses four major shortcomings: the limited personal scope of application of the regime and its inconsistency with the PRIIPs Regulation; the difficulties for product distributors in defining a target market for the mass of products manufactured by manufacturers not subject to MiFID; the compliance burden for distributors relating to the requirement to give feedback to manufacturers; and the problem of self-censorship by financial institutions. Each of these shortcomings result in reductions of the product offer for investors, without a correspondent increase in investor protection. The contribution offers concrete proposals for amendment of the PRIIPs Regulation and the ESMA Product Governance Guidelines to remedy those shortcomings. The contribution concludes that even though this may not have been the intent of the legislator, the effects of the MiFID II product governance regime represent nothing less than a paternalistic revolution. The author argues that, without losing the potential benefits of the product governance rules as a means of investor protection, the proposed amendments would result in an improved scope of the product governance rules, alleviate the compliance burden for distributors and allow the product governance rules to get rid of their paternalistic edge.