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CSSF Circular 23/840: Update to ESMA’s Guidelines on MiFID II Product Governance Requirements

21 September 2023

Regulatory News Alert

Context and objectives

In recent years, the financial sector has witnessed a paradigm shift toward more transparent and responsible practices. In March 2023, the European Securities and Markets Authority (ESMA) took a further step in this direction by releasing the Final report on "Guidelines on MiFID II product governance requirements" (ESMA35-43-3448). This report builds on the previous text of the 2017 ESMA Guidelines (ESMA35-43-620) and provides updates to further clarify the application of certain aspects of the MiFID II product governance requirements.

Through the issuance of CSSF Circular 23/840, the CSSF now officially adopts the said updated ESMA Guidelines and asks all entities in scope to comply with the guidelines from 3 October 2023 onward.

The guidelines are a testament to ESMA's commitment to:

  • Transparency: Ensuring that financial products are designed and marketed in a manner that is clear and understandable for the target market;
  • Investor Protection: Safeguarding the interests of investors by ensuring that products are suitable for their intended target market;
  • Regulatory Alignment: Ensuring that practices across the EU are harmonized, reducing discrepancies and fostering a unified financial market.

The guidelines apply to firms and competent authorities involved in the manufacturing or distribution of financial instruments and structured deposits. They emphasize the importance of understanding the needs and characteristics of the target market and ensuring that products are designed and distributed accordingly.

The CSSF clarifies that Circular 23/840, and thus the ESMA guidelines, apply to:

  • Investment firms and credit institutions providing investment services, performing investment activities, or selling or advising clients in relation to structured deposits;
  • UCITS Management Companies providing the investment services of portfolio management for discretionary mandates, or investment advice;
  • External Alternative Investment Fund Managers providing the investment services of portfolio management for discretionary mandates, investment advice or reception and transmission of orders.

ESMA’s expectations

We have summarized the main changes in the principles that entities under the purview of these guidelines are expected to adhere to, in comparison to the previous version of the guidelines:

1. Sustainability-related objectives and preferences

  • Firms may specify sustainability preferences in line with the MiFID II Delegated Regulation. This includes aspects such as the minimum proportion of the product invested in environmentally sustainable investments or sustainable investments, the principal adverse impacts (PAI) on sustainability factors considered by the product, and whether the product focuses on environmental, social, or governance criteria.
  • For products that take into account sustainability factors, firms are not required to identify a negative target market concerning their sustainability-related objectives. The sustainability-related objectives of such products only contribute to identifying a "positive" target market in terms of clients with compatible sustainability-related objectives. These products can still be distributed to clients outside that "positive" sustainability-related target market, provided they align with the features of other target market categories defined by the guidelines.

2. Identifying the target market by applying a clustering approach

  • Manufacturers can group products with similar features ("clustering approach") for target market identification. Clusters should be homogeneous in characteristics and risk features. The clustering approach requires regular checks to ensure products fit within their designated clusters.

3. Distribution strategy decisions

  • An emphasis is put on ex-ante consideration of the client base in product governance decisions by the management body.
  • Distributors should decide which products will be recommended or offered to certain groups of clients based on their knowledge, experience, and financial situation. Where the distributor considers that a more complex product with a relatively narrow target market that can also be distributed under non-advised services, it should identify additional measures to ensure that the distribution strategy is compatible with the product’s target market. In such cases, distributors should consider aspects such as the marketing strategy that should be followed for the product and whether and how the product should be displayed in the client’s choice environment. In addition, consideration should be given to additional bundled or ancillary services, such as provision of loans allowing clients to carry out the transactions.
  • Some of the more stringent proposals, like banning sales outside of target market for hedging purposes, proposed in the final report, did not make it into the final guidelines. At the same time, the requirement that distributors cannot deviate from fundamental decisions made by the manufacturer on the target market, remains in the final guidelines.
  • Distributors need to periodically report on distribution to manufacturers based on the periodic reviews.

4. Review of products

During the regular review of the products’ target market, distributors and manufacturers should use both quantitative and qualitative criteria, relating to the product’s characteristics, market conditions and distribution. Firms should determine the frequency and depth of product reviews while taking into account the nature of the product and, where appropriate, the service. Distributors are required to review products as long as they are offered, sold or recommended but may stop the review if products are no longer sold to clients.

Next steps

The guidelines come into effect on 3 October 2023. ESMA expects all relevant entities to align their practices with these guidelines and ensure consistent application across the EU.

What does this mean for your organization?

The guidelines emphasize the importance of product governance in the financial sector. Firms and authorities should review their existing product governance practices and ensure they are in line with the new guidelines. This includes understanding the target market, designing products that meet their needs, and regularly reviewing and updating their approach.

How can Deloitte help?

Deloitte can assist in:

  • Interpreting the guidelines and ensuring that firms and authorities understand their implications.
  • Implementing the guidelines effectively, ensuring compliance with MiFID II requirements.
  • Identifying the potential target market for products using both qualitative and quantitative criteria.Integrating the guidelines into existing risk management frameworks and ensuring regular reviews.
  • Conducting training sessions and workshops to ensure stakeholders are well-versed with the guidelines.

By leveraging our expertise, organizations can ensure that they not only comply with the guidelines but also use them as a strategic tool for product development and governance.

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