How good is your Product Governance Framework?

Scrutinise your Product Governance Framework

“Product oversight and governance refers to the systems and controls firms have in place to design, approve, market and manage products throughout the products' lifecycle to ensure they meet legal and regulatory requirements.”  Financial Conduct Authority, PROD 1.1.2

Under MiFID II and Consumer Duty, UK firms are required to implement an appropriate product governance framework. But how do you structure that framework? And how do you ensure that your framework is effective?

Firstly you need to understand the regulatory expectations.

Regulatory Expectations

Under Consumer Duty, products and services must meet customers’ needs and offer fair value. Given the current cost of living crisis, the regulators are focusing attention on this specific area and encouraging firms to identify vulnerable customers and ensure that products and services do not disadvantage this category of customer.

Secondly, what other regimes impact your product framework? If you’re providing investment management services, then you’ll also need to consider MiFID II and perhaps various other fund management regimes too.

Regardless of the activity that you’re undertaking and whatever regime you’re obligated to follow, firms need to consider the end goal.

The purpose of good product governance is to ensure that a firm’s products and services meet the regulatory requirements and thereby, prevent harm to the consumer or investor. If your product governance framework is to be effective, then it needs to encompass the full lifecycle of any product or service being offered. This means that firms need to document the decisions and rationale behind the design and launch of a product through to regular reviews and eventually closure of that product or service. 

The starting point is establishing the Product Governance Committee led by senior management to enable appropriate decision making.  It’s crucial that this Committee has the right skillset and grasp of business activities to make informed decisions. Those decisions will be informed by the management information (MI) provided to the Committee, which might include findings from any market surveys, product reviews, key performance metrics relating to products, services and complaints together with analysis of that data.

The Committee needs to assess the adequacy & relevance of the MI provided to enable the Committee to assess any risks posed by the products and services.  Regarding product reviews, these should be conducted regularly, and the findings acted upon. The Committee should be aware of any identified vulnerabilities, which should be escalated in a timely manner, to prevent foreseeable harm occurring. Additionally, this aids the cycle of regular review and continuous improvement.

Image 1:  Product Governance framework

How does Product Governance impact customers?

In relation to product governance the Consumer Duty has several impacts that require firms to demonstrate:

• Acting in good faith by acting in the best interests of the customers
• Avoiding foreseeable harm by identifying and preventing detriment to customers
• Fostering informed decision-making by providing clear, concise and relevant information to help consumers make informed financial decisions
• Delivering good outcomes by ensuring that products and services deliver the expected benefits and values to customers
• Considering the needs of vulnerable customers & ensuring this group is not disadvantaged.

Some of these elements are also echoed in the MiFID requirements.

Originally introduced 17 years ago, MiFID I aimed to harmonise the requirements for investment management services across the EU states by increasing investor protection and transparency. The financial crisis of 2008 highlighted some shortcomings in the regime which sparked various debates and culminated in the introduction of MiFID II and MiFIR in January 2018. Enhancements were made to increase market transparency, strengthen investor protection and reduce risks in financial services. The scope of MiFID was also extended to include commodities & derivatives, and introduce more stringent regulatory reporting.

To aid investor protection and transparency, firms must address the following items to demonstrate robust product governance:

• Design & Development: Products must be designed to meet the needs, objectives, and characteristics of a specified target market. Firms need to have a clear understanding of their target market  Additionally, they must establish a formal product approval process that involves senior management and compliance teams to assess risks, costs and benefits.
• Target Market Identification: Firms must have clear definitions and an understanding of the target market for each individual product. Firms need to demonstrate that the product is appropriate for the intended customer base.
• Rigorous Testing & Review Processes: Firms must ensure the suitability and value of the products being offered. This requires firms to conduct scenario and stress testing to understand how products might react to changes in the buying patterns and the behaviours of investors as well as market conditions.   At this stage firms should also evaluate how the product offers value to the target market regarding costs, and potential returns too.
• Distribution Strategy: To prevent harm to the end user, it is crucial that firms select appropriate distribution channels. This means that distributors both understand the product and the target market, as well as implementing appropriate governance by way of regular reporting and oversight.
• Product Monitoring & Review: Once a product is launched, the firms need a ongoing assessments of their products to ensure that they remain fit for purpose, meet the customers’ needs and to ensure early identify and remediation of any issues or customer detriment.
• Compliance Document & Disclosures: This requires firms to maintain appropriate records relating to decisions made and product reviews and outcomes. Firms also need to be mindful of making timely regulatory reports where reviews identify adverse findings or the need for significant changes to products.
• Distribution oversight: Whilst distribution strategy is essential, it’s equally important that firms conduct due diligence on any distribution channels as well support these distributors by providing training and ongoing support to help avoid mis-selling or customer harm.
• Client Communications: The ability to demonstrate compliance with the requirements includes ensuring transparency, accuracy and comprehensive information is provided to customers about the products being offered.

The above factors feature in the FCA's thematic work within general insurance.

FCA Thematic Work - General Insurance and Protection Products: 

This review considered whether this sector was meeting its regulatory obligations under the Product Governance rules. The report highlighted the following areas of importance:

• the ability to demonstrate compliance with PROD 4, where firms are responsible for ensuring the products they manufacture and distribute offer customers fair value
• the assessment of products and services to provide fair value and effective product governance arrangements to deliver good outcomes for customers
• implementation of appropriate systems and controls to support the new requirements
• proactive and appropriate action taken when actual or potential issues have been identified, such as products not providing the intended value.

The report identified specific areas for improvement for both manufacturers and distributors.

Manufacturers:

Whilst most manufacturers had strengthened their oversight and governance arrangements,  weaknesses and inconsistencies were identified in meeting PROD 4 requirements which included the inability to demonstrate effective product governance frameworks.  This included lack of evidence to support how firms concluded that products offered fair value and good outcomes. Firms must demonstrate robust challenge when discussing the value of products, with clear decisions that are supported by appropriate evidence in product reviews and the Fair Value Assessments (FVAs).

Importantly, manufacturers need to demonstrate that they have appropriate MI and analysis that not only supports their decision making, but enable firms to proactively identify value problems and act swiftly to address these issues. This is particularly relevant when it comes to FVAs and regular review of products.

Manufacturers must:

• demonstrate due consideration to the total price paid, including the impact of remuneration on the overall value of a product
• have sufficient MI to monitor distributors’ remuneration and ensure consistency with providing fair value to their customers
• have sufficient, good quality MI to assess value, or appropriate metrics to identify fair value problems
• demonstrate how they assess whether the product is delivering fair value to all customers, including vulnerable or outlier groups of customers

Additionally, the FCA found that Target Market Statements were too high level and lacked granularity. Failing to adequately define the target market could lead to products being sold to the wrong client segment resulting in failure to provide fair value or a good outcome. As well as weaknesses in the defining the target market, where several firms are involved in the manufacture of products, many firms didn't understand or meet their responsibilities under PROD 4.2.  How well does your firm document its applicable rules universe, and demonstrate compliance with its obligations?

This sends a clear message to manufacturers to consider their distribution channels and choice of distributor. This means ensuring that the distributors understand the products being sold and the intended target market to avoid products being offered to the incorrect clients. Additionally, appropriate and timely information needs to be shared with the distributors. How do you currently send and receive information from your distributors?  How could this be improved?

An effective framework means that manufacturers have a full audit trail of their assessments during each stage of the product governance process. Supporting evidence, metrics, management information and ongoing monitoring is in place to identify potential issues quickly, and most importantly, to resolve issues and prevent them recurring.   

Distributors:

The FCA’s review confirmed that some distributors had strengthened governance and oversight. There was clear evidence that senior managers had taken responsibility by considering the impact of their activities and remuneration on products and delivering value to customers. However, more was needed to demonstrate that the firms understood their responsibilities.

It is crucial that distributors understand the products which they’re selling as well as the intended target audience and value. When distributors understand these elements, it reduces the risk of harm to the customer. The FCA found the following failings relating to distribution arrangements:

• Lack of clarity regarding governance structures and processes. This leads to inability to demonstrate clear responsibility, rationale and evidence of key decisions. This is of particular concern when harm is identified, and action is required
• Lack of detail and failure to consider key areas of distribution strategy, target market, distribution strategy and the products intended value
• Failure to obtain sufficient information to understand the target market, distribution strategy and intended value to the customer
• Failure to implement a distribution strategy to meet PROD 4.3 requirements which is aligned to the manufacturer’s distribution strategy for each product
• Insufficient MI and analysis to enable reviews and assessment.

Summary findings:

Whilst the findings above relate to one specific sector within financial services, it indicates the regulatory concerns and highlights where firms regardless of sector should focus their attention.  There is more work to be done and firms should consider the findings in light of their own frameworks. 

Firms need to ensure that they have a clear product strategy, supported with appropriate management information, clear communications, both internally and externally, to ensure products reach the intended target market with ongoing monitoring and reporting to senior management.

Needless to say, this requires robust governance and a clear audit trail of assessments, decisions and ongoing risk assessments.  Crucially, firms need to know which rules apply to them and demonstrate how they're fulfilling their obligations.

Ruleguard  and Product Governance:

Ruleguard is an industry-leading GRC platform designed to help regulated firms manage the burden of evidencing and monitoring compliance. It has a range of tools to help firms fulfil their obligations across the UK, Europe and APAC regions.

Ruleguard's Consumer Duty solutions enable firms to automate processes, create and maintain the crucial evidence trail, whilst also sharing information with third parties to provide more robust oversight and manage regulatory risk.  Ruleguard can also facilitate the due diligence process to help firms assess  and maintain oversight of third parties.

How Ruleguard can help

With Ruleguard, compliance with the Consumer Duty becomes less of a challenge and more of a competitive advantage.

 

Strategically align your products with regulatory expectations and client interests with Ruleguard’s proactive Product Governance solution.

 

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About the author

In a career spanning 30 years, Priscilla has worked as a consultant, CCO and MLRO providing regulatory oversight and advice to firms across the financial services industry. She is responsible for our thought leadership programme, writing regular articles and white papers, and hosting webinars on a variety of regulatory matters.

She is a Fellow of the International Compliance Association, a certified GRC practitioner, and a member of the Institute of Risk Management.

 

Contact Priscilla