FIDLEG SOLUTION - News 4/2018

The Use of EU Distributors by Swiss Asset Manager under MiFID II

INTRODUCTION

This issue of the MiFID II series of FIDLEG SOLUTION – News 4/2018 discusses how Swiss Asset Managers can rely on third party EU distributors for the distribution of their services and products, in particular funds, in the European Union.

USE OF EU DISTRIBUTORS TO ESCAPE FROM MIFID II PRODUCT GOVERNANCE RULES?

MiFID II contains very strict and never seen before product governance rules. The purpose of these rules is to make sure “that financial instruments are offered or recommended only when in the interest of the client” (MiFID II, Preamble 71) in order to enhance investor protection.

These product governance rules create a massive administrative burden and costs. A Swiss Asset Manager may thus wonder whether and how he could escape from this regulatory burden.

An often-heard solution is the engagement of distributors or placement agents in the European Union. Doing this, the Swiss Asset Manager does not distribute its financial products in the European Union itself but rather remains in Switzerland and makes this done by a third party. One could hope that this would relieve the Swiss Asset Manager from the product governance rules.

However, the Swiss Asset Manager will soon be disappointed: By simply engaging a third party, one is not relieved from the burden of the product governance rules of MiFID II.

THE LEGAL BASIS FOR THE MIFID II PRODUCT GOVERNANCE RULES

The principal legal basis of the products governance rules is set forth in art. 16(3) and art. 24 MiFID II.

In short, art. 16(3) MiFID II requires investment firms to maintain and operate effective organisational and administrative processes for the manufacturing of their financial products with a view to taking all reasonable steps designed to prevent conflicts of interest.

And art. 24 MiFID II requires investment firms to ensure that their financial instruments are designed to meet the needs of the identified target market. The purpose of all this is to avoid that products are sold in the European Union which are not suitable or appropriate for the targeted investors.

On 2 June 2017, the European Securities and Markets Authority (ESMA) published its Final Report on MiFID II Product Governance Guidelines to safeguard Investors (Read here). These Guidelines serve the purpose to make sure that the product governance rules are applied in a uniform way throughout the entire European Union.

WHAT ARE THE MIFID II PRODUCT GOVERNANCE RULES?

The MiFID II product governance rules can be subdivided into rules applicable to the manufacturer of the financial instruments and those applicable to the distributors of the financial instruments. In short, these rules require the following:

For the product manufacturer, MiFID II requires that they consider their responsibilities to the ultimate end client rather than treating distributors as the clients. The manufacturer has to take the following actions in order to comply with MiFID II:

  • Identification of the Target Market applying both a qualitative and a quantitative approach. There are six categories: (i) type of clients to whom the product is targeted, (ii) knowledge and experience of the targeted investors, (iii) financial situation with a focus on the ability to bear losses, (iv) risk tolerance and compatibility of the risk/reward profile of the product with the target market, (v) client’s objective, (vi) clients’ needs. This includes the definition of a negative target market, i.e. the market which the products do not target.
  • Definition of the distribution strategy and select distributors whose clients and services are aligned with the target market as defined before.

Based on this, the EU distributors will need to have in place explicit product governance arrangements, including an understanding of the financial instruments being offered or recommended, an assessment of the compatibility of the financial instruments with the needs of their clients, and will need to ensure that the financial instruments are offered or recommended only where it is in the interests of the client. For this, the distributors have to take the following actions:

  • Specify the target market based on the same six criteria as the manufacturers (see above), using information about their client base.
  • Put in place a process at an early stage for the definition of the distribution strategy.
  • Make sure that the process for the definition of the target market is in the hands of others than the suitability and appropriateness test.

These obligations accompany the entire lifecycle of a product, i.e. from their initial design of a product until the review and re-assessment of the placed products.

AND HOW DOES THIS AFFECT SWISS ASSET MANAGERS?

As MiFID II is a legislation of the European Union of which Switzerland is not a party, one may question how this affects Swiss Asset Managers.

The answer is easy: The EU distributors appointed by Swiss Asset Managers may require the Swiss Asset Managers to provide them with all the information so that the distributors can satisfy the product governance rules applying to them. They must take all reasonable steps to ensure that the level of product information from the Swiss Asset Manager is of a reliable and adequate standard to be distributed in accordance with the distributor’s target market and, where such information is not publicly available, to require the entry into a suitable written agreement to provide all relevant information.

It follows that if a Swiss Asset Manager wants to distribute or make distributed within the European Union his own financial products, he has to abide to the product governance rules and to deliver to the EU distributors all the information which they require under the MiFID II product governance rules.

THERE IS MORE TO COME…

The next issue of the MiFID II series of FIDLEG SOLUTION – News 5/2018 shall discuss the new European data protection rules (General Data Protection Regulation; GDPR) and how they affect Swiss Asset Managers.

Your FIDLEG SOLUTION Team
www.fidlegsolution.ch


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