Product governance requirements were formally applied in the United Kingdom in 2018 through the FCA Handbook on product governance (“PROD”), which transposed the comparable MiFID II requirements into UK legislation. PROD applies to all MiFID investment firms, amongst other categories of covered entities.

At the start of February 2021, the European Securities and Markets Authority (“ESMA”, the EU’s securities markets regulator) announced the launch of a common supervisory action (“CSA”) with national competent authorities on the application of PROD rules under the MiFID II Directive (2014/65/EU) across the European Union (EU).

On a very relevant and helpful note, the Financial Conduct Authority (“FCA”)  published the results of its “MiFID II: product governance review” in the UK (“FCA Review”) on 26 February 2021, which gives an indication of how UK firms are faring, albeit based on a preliminary and limited sample size. Other than giving an indicative idea of the progress made since PROD implementation, the findings of the FCA Review will be helpful in terms of highlighting what other UK firms can watch out for when self-assessing, in a bid to review and ensure their PROD compliance.


The FCA Review looked at PROD in a sample of 8 asset management firms (each with group assets under management ranging from £2bn to over £100bn) and examined how these firms, as product providers (manufacturers), take MiFID II’s PROD rules into account, particularly the interests of the end clients, throughout the product lifecycle.

All the products assessed were UK-authorised collective investment schemes, available to retail investors through platforms on both an advised and an ‘execution-only’ (non-advised) basis. The funds included a range of strategies that covered equity, derivative and fixed income assets with a total value of around £7bn.

The FCA then evaluated its findings against relevant requirements and guidance in the FCA Handbook, such as those under the ‘Regulatory Context’ section as well as Systems and Controls (“SYSC”).


The FCA grouped its key observations into 4 main areas as follows:

(1) Product design

How well firms assess the negative target market: Of the reviewed firms, only 1 manufacturer appeared to have considered the ‘negative target market’ concept, but it could not identify the specific group of consumers that would be a ‘negative target market’ for its UCITS and NURS products. An instance of a negative target market that overlapped with an existing investor-base (where the negative target market was defined as investors who wished to hold the investment for longer than 5 years, yet the firm recognised that some investors could remain invested beyond that timeframe) was also highlighted. The FCA reiterated that PROD requires firms to:

  • identify the potential target market for each financial instrument and specify the type of clients the product is compatible with, or not (a negative target market);
  • determine whether the risk/reward profile is consistent with the target market; and
  • carry out these activities to enable them to comply with the customer best interest rules.

Management of conflicts of interest. Whilst all reviewed firms had a framework for managing conflicts of interest, not all appeared to be effective. The FCA expects firms to:

  • identify, manage and mitigate potential conflicts while providing a service;
  • consider whether there are certain product characteristics, such as charges, objectives or its general operation, that could benefit the firm at the expense of the end investor; and
  • consider whether there are conflicts which may create incentives to favour one set of investors over another.

Fundamentally, the ultimate outcome is as important as having a framework in place to manage conflicts of interest, to avoid damaging the interests of a client or the risk of breaching applicable conflicts of interest rules.

(2) Product testing

Scenario and stress testing: The asset managers’ approaches varied and the FCA iterated that to protect investors, PROD asks certain firms to carry out scenario analysis to assess the risk of poor outcomes to consumers and the circumstances in which they may occur. This includes assessing resilience in volatile market conditions and scenarios that may affect how an individual product performs. Stress tests should cover adverse market conditions, including the firm’s own financial strength, asset-specific stresses and any risks from a highly concentrated consumer base.

How firms disclose costs: Where it came to cost disclosure, the FCA highlighted that there are still areas where firms need to improve their costs and charges disclosures. Some cost information shown in marketing documents did not match the information shown in regulatory documents such as the UCITS Key Investor Information Document and most of the firms assessed also appeared to leave out certain charges, particularly portfolio transaction costs, from their cost disclosures. The FCA expects manufacturers to:

  • disclose costs and charges in a way that is clear, fair and not misleading;
  • comply with relevant regulatory requirements; and
  • ensure wider marketing material reflects the underlying characteristics of a product and give a fair and clear account of charges, including portfolio transaction costs.

(3) Distributors

Due Diligence: It was found that the quality of due diligence over distributors varied with some firms assessing a distributor’s arrangements more robustly than others. The FCA emphasised that due diligence means:

  • asset managers can establish whether their chosen distributors are fit for purpose in client onboarding; and
  • consider if a distributor’s intended product recipient matches the product’s target market.

Failing to do so increases the risk that products end up in the hands of consumers for whom they are not appropriate, which could cause harm to investors.

Information sought by firms from distributors: It was noted that all the asset managers faced challenges in getting end-client data from distributors, even when they specifically asked for this information. A recurrent theme was that asset managers feel unable to influence distributors because of the commercial sensitivity of the data request and the asset manager’s size was also sometimes described as a factor. The most problematic area involved pooled nominee accounts for execution-only clients where asset managers rely on distributors for end-investor information. Whilst acknowledging these challenges, the FCA continued to underscore the importance of firms insisting on – and even challenging – their distributors for end-client data trends (and to document the challenge) as part of the work required to move towards a more collaborative relationship that allows asset managers to meet their obligations to act in clients’ best interests.

Management information: The systems and procedures for monitoring data internally varied, as did the ways in which firms use management information. The FCA brought up the 2015-published ‘Treating customers fairly – guide to management information’, which it reminds remains relevant in giving examples of good and poor practice and helping firms develop management information. Noting the challenges asset managers face in getting information from their distributors, the FCA urged firms to consider this guide and how they can improve their management information to help identify and monitor key trends that may lead to emerging risks.

(4) Governance & oversight

It was found that nearly all the firms carried out a formal product assessment or review every year. However, varying levels of oversight and challenge across these governance channels showed up, across the different firms.

Second line of defence and committees: It was found that all asset managers had PROD committees, but some fell short of the FCA’s expectations. The role of the second line of defence was often poorly defined, limiting the potential for meaningful challenge.

Authorised Fund Manager (“AFM”) Board: While firms were aware of the AFM Board’s PROD obligations and the need for oversight of the relevant committees’ work or their second-line functions, there was variation in the quality of contribution from the independent Non-Executive Directors. Instances of reasonable challenge were seen only in some of the firms and/or only in the director’s established field of expertise.

Record keeping: The FCA found that most of the visited asset managers had poor record keeping, which might have been due to a lack of formal process in product design and oversight. Critically, where firms did not document challenge, decisions and checks, they were unable to recall what activities had taken place. The FCA highlighted that this inability to evidence robust challenge and oversight should raise concern for the individuals accountable and mentioned the new Senior Management and Certification Regime (as well as SYSC 9.1.1R compliance).

Training: It was found that the quality and focus areas of relevant training varied and did not always include the importance of the needs of and outcomes for the end investor. The FCA reminded that demonstrating required knowledge and competence is considered necessary in complying with SYSC 5.1 and it is important that staff are sufficiently experienced on the characteristics of the firm’s financial instruments, the investment services provided and the needs, characteristics and objectives of the identified target market, in order to enable the asset manager to have effective control over their PROD processes to ensure the right investment service reaches the respective target market.


The FCA’s conclusion from its review was that there is significant scope for asset managers to improve their PROD arrangements as some asset managers are not undertaking activities in line with MiFID II’s PROD regime and this increases the risk of investor harm, particularly where investors end up buying products that are not appropriate.

The FCA also mentioned that the reliance on intermediated services in the UK investment market also means manufacturers commonly rely on those who distribute their products to give them relevant information on the end consumer. However, the FCA Review showed that distributors rarely pass this information on to asset managers, hindering firms’ ability to effectively meet best practice on PROD. Hence, asset managers and product distributors need to prioritise effective cooperation and information sharing to address the potential harm to consumers from poor product design and distribution processes.

Unsurprisingly, in light of the FCA Review’s observations, the FCA indicated that it is likely to undertake further work on the subject, including to consider whether it would need to make further changes to the PROD rules and guidance for both asset managers/manufacturers and distributors, to better address the key sources of harm throughout the product lifecycle. In terms of expectations and enforcement in relation to firms, the FCA expects firms to ensure their activities prioritise good customer outcomes and that they comply with the relevant regulatory rules and requirements. Where potential breaches are identified, the FCA will consider if action, which may include opening investigations or other appropriate measures, is required.


In the FCA Review, the FCA also reminded firms that AFMs are required to act in the best interests of the funds they manage and those who invest in those funds, under rules in the Conduct of Business Sourcebook (COBS), the Collective Investment Schemes (COLL) Sourcebook and the FCA’s Principles for Businesses (the Principles). While PROD rules apply to AFMs as guidance, firms are expected to carefully consider them when meeting their obligations to ensure they comply with the FCA’s Principles and other relevant rules. Indeed, acting in line with PROD would enable AFMs to comply with some of these other requirements.

Other Directives that set rules and requirements over authorised funds and AFMs as well as alternative funds include, principally, the UCITS Directive and the Alternative Investment Fund Managers Directive (“AIFMD”), respectively. Additionally, in September 2019, the FCA also introduced new rules requiring AFMs to carry out an assessment of value for relevant UK authorised collective investment schemes (COLL 6.6.20R).

Nonetheless, MiFID II provide granular detail on PROD requirements and the framework which PROD provides is therefore important in ensuring that firms act in the best interests of the investors in their funds.

AFMs should also consider the guidance in the Responsibilities of Providers and Distributors for the Fair Treatment of Customers (“RPPD”), which sets out the FCA’s view on what various rules require of providers and distributors in certain circumstances to treat customers fairly, from a practical perspective.


It seems that further study and change may be on the horizon, with lots of guidance to related rules and guidance highlighted in the meantime by the FCA to help firms assess and improve their PROD practices and compliance.

Other than keeping in mind the above from the FCA Review, a thorough and prudent way to go about an internal review and update of PROD compliance would be a study and assessment  of how internal processes and procedures measure up against PROD, the ESMA guidelines and ESMA Q&As as well. For a summary of how the ESMA Q&As touch upon the key areas of analysis that ESMA intends to focus on in the ongoing CSA, please click here.

For more information, and any guidance or advice on PROD and the obligations on manufacturers and distributers, Cleveland & CoTM, your external in-house counsel, are here to help.