Product governance: Who owns suitability?
FBC Executive Governance Roundtable, 3 June 2021
With the publication of the Financial Conduct Authority’s (FCA) product governance review in February, the regulator has highlighted what it sees as shortcomings in the asset management industry with regard to suitability.
For iNEDs, the FCA’s review can be summed up as ‘must try harder’. It reported “variation in the quality of contribution” from independent directors, and a tendency for iNEDs to focus only on their areas of expertise “leading to a potential lack of proactive challenge in other areas”.
But is it fair for the FCA to put so much emphasis on suitability from the product manufacturer’s perspective, when the distribution chain – in the UK in particular – has become so long and fragmented? And how can managers hope to meet suitability requirements with so much intermediation between them and their ultimate customers?
These issues and more were addressed at a recent FBC Executive Governance Roundtable focusing on the review, which took place on 3 June.
Policing the distributors
The overarching topic of the discussion related to asset managers’ relationships with distributors, in particular platforms, but also financial advisers and wealth managers.
Most of the time, asset managers have far less power than these distributors when it comes to understanding the client. Advisers and wealth managers have the direct relationships, while investment platforms – whether direct businesses such as Hargreaves Lansdown or adviser-facing offerings such as Aegon – can get amalgamated views of client trends.
For asset managers, however, the picture they get is fragmented. Different distributors will give information in different ways and in different formats or more often not providing it at all. This presents challenges to asset managers in obtaining and using this information for the purposes expected by the FCA, including establishing if their products are reaching a ‘target market’.
The regulator acknowledges these challenges: “A recurrent theme was that asset managers feel unable to influence distributors because of the commercial sensitivity of the data request. The asset manager’s size was also sometimes described as a factor in this. The most problematic area involved pooled nominee accounts for execution-only clients where asset managers rely on distributors for end-investor information.”1
Nevertheless, the FCA is clear that it wants more effort from manufacturers to get information from distributors.
“It appears that commercial agreements and sensitivities between asset manager/product provider and distributor may be taking precedence as asset managers are reluctant to insist on end-client data trends from their distributors,” the regulator states. “In our view, asset managers could do more to challenge their distributors for this information – and document that challenge – to work towards a more collaborative relationship that allows asset managers to meet their obligations to act in clients’ best interests.”2
Some attendees lamented a “mismatch” in the balance of regulation between asset managers and platforms. There is a regulatory responsibility, derived from MiFID II, for distributors to provide information on clients to manufacturers3. However, asset managers report anecdotal examples of distributors refusing to pass on this information on the basis of them not meeting the strict definition of a distributor under the rules.
This mismatch in understanding may stem from MiFID II’s European roots. The predominant distribution model on the continent is via banks or insurers direct to the customer, giving these organisations’ internal asset managers much clearer sight of the end client. The UK’s more varied and intermediated models are, arguably, ill-suited to an efficient reciprocal flow of information.
As one person stated: “Something’s got to give in terms of the regulatory intensity across the chain.”
Filling in the gaps
There were ways in which asset managers could work with distributors to improve information sharing, attendees heard.
The discussion explored one asset manager’s work on a real estate fund, which had involved drilling down through the distribution chain to identify different sections of the product’s investor base. The driver for this had been fund liquidity management scrutiny by the FCA given issues faced by some property funds due to Brexit and Covid-19 impacts. While this demonstrated that it was possible to obtain the type of data the FCA was looking for, it was highly manual, costly and challenging to do so, indicating that it was not scalable to all funds.
Existing fund flow data can be used to monitor trends, panellists agreed. Depending on the type of distributor, asset managers can look for spikes in flows and ask questions to distributors to understand the underlying drivers. This could include drilling deeper into how particular funds are marketed or positioned on distribution platforms or used by advisory or discretionary fund management firms. For example, an increase in inflows into one particular asset class, such as emerging market equities, could be linked to a change in asset allocation from a wealth manager. However, if the increase came from a direct platform, it might be worth investigating to check that third parties were marketing and positioning the product in a way which is consistent with the nature of the fund (including the target market highlighted by the manufacturer).
Equally, as one attendee highlighted, “hobbyist” investors can be more speculative, so a positive engagement process with platforms and distributors was necessary to ensure managers do not ‘point the finger’ too hastily.
“Monitor these platform patterns to see whether they are surprising or not,” the speaker said. “If it’s an advisor platform without its own multi-asset funds, you would expect that your multi-asset funds might be the more heavily used funds. You’re looking for these patterns to see if they fit with what you expect.”
As the FCA states, failing to adequately monitor distribution “increases the risk that products end up in the hands of consumers for whom they are not appropriate, which could cause harm to investors”. When these headlines appear, they are unlikely to draw the distinction between manufacturer and distributor.
For larger firms, attendees heard that interactions with the FCA have been positive. This is largely because the regulator spends more time with these larger companies – understandable, given the size of their client bases.
One question raised by the FCA during these interactions concerned a company’s product “kill list”, i.e. the product ideas that didn’t make it. As one panellist explained, this was a key indicator of an asset manager’s governance and due diligence procedures, as it demonstrated how they assessed whether a new fund or strategy would succeed.
The panellist described the kinds of questions the FCA asked about the product ideas that never made it: “Have you got documentary evidence of these [ideas] and why they never made it through? Was it because you couldn’t cope with them in an administrative or operational sense? Was it that you didn’t have the fund management capability? Was it that the demand you thought was there wasn’t quite there?”
PROD – the MiFID II product governance regime – is wide reaching and demanding of asset managers. The FCA’s review suggests no let-up in this pressure. However, there are ways in which managers can attempt to work with distributors to improve the flow of information and encourage the sensible and suitable sale of investment products.
1 MiFID II: product governance review, Financial Conduct Authority, 26 February 2021. https://www.fca.org.uk/publications/multi-firm-reviews/mifid-ii-product-governance-review
2 MiFID II: product governance review, Financial Conduct Authority, 26 February 2021. https://www.fca.org.uk/publications/multi-firm-reviews/mifid-ii-product-governance-review
3 PROD 3.3.30R, which says that distributors must provide information on sales and other things including complaints.