Product Governance under PRIIPs and MiFID II: Ensuring Compliance and Protecting Investors

Product governance under PRIIPs and MiFID II has become an essential part of regulatory frameworks that govern investment products and services across the European Union. These regulations aim to protect retail investors by ensuring that investment products are designed and distributed appropriately, taking into account the needs and characteristics of the target market.

PRIIPs (Packaged Retail and Insurance-based Investment Products) and MiFID II (Markets in Financial Instruments Directive II) provide clear guidelines on the design, distribution, and transparency of financial products. This article will explore the key obligations these regulations impose on firms involved in the creation and sale of investment products and the legal consequences of mis-selling.

Obligations When Designing and Distributing Investment Products

One of the main objectives of product governance under PRIIPs and MiFID II is to ensure that investment products meet the needs of the target market, particularly retail investors. These regulations provide a set of rules that firms must follow when designing and distributing investment products to ensure they are suitable and transparent.

Target Market Assessment

Both PRIIPs and MiFID II emphasize the importance of assessing the target market when designing and distributing investment products. Firms must consider the investment objectives, financial situation, and risk tolerance of their clients before offering a product. For example, under MiFID II, investment firms are required to identify the appropriate target market for each investment product, taking into account the type of clients the product is suitable for and the risks involved. Similarly, PRIIPs regulations require firms to assess whether a particular product is appropriate for retail investors, considering their understanding and risk appetite.

This target market assessment helps ensure that the right products are offered to the right clients and that investors are not exposed to products that may be too complex or high-risk for their needs. The regulations further require that investment firms ensure products are not marketed to a broader audience than intended, thereby protecting vulnerable retail investors from unsuitable products.

Product Design and Approval Process

Under PRIIPs and MiFID II, firms are required to follow specific processes when designing investment products. These regulations require firms to establish a structured product approval process, which involves identifying the product’s characteristics, its target market, and the potential risks to the investor. The approval process should involve thorough due diligence, ensuring that the product is in line with both regulatory requirements and client interests.

For example, under PRIIPs, product manufacturers must ensure that the products meet certain standards for transparency, particularly in terms of providing clear information about risks, charges, and performance. The aim is to help investors make informed decisions about the products they choose. The product governance obligations also mandate that firms keep detailed records of their product approval processes and any changes made to products over time.

The design process under MiFID II also focuses on ensuring that products align with the regulatory requirements for suitability and appropriateness. Firms must ensure that investment products are designed with the investor’s needs in mind and that appropriate risk warnings are provided.

Product Monitoring and Review

Once an investment product has been approved and is being distributed, firms must continuously monitor and review the product’s performance in relation to the target market. Both PRIIPs and MiFID II require firms to regularly assess whether a product continues to meet the needs of its target market. This includes evaluating whether the product’s performance is in line with expectations and whether any changes in the market environment or regulatory landscape might affect the product’s suitability.

Product governance obligations under both regulations require firms to take action if they identify that a product is no longer suitable for its target market. This could involve reviewing product terms, re-evaluating the target market, or even withdrawing the product from the market if it is deemed unsuitable. Regular monitoring helps ensure that products remain aligned with regulatory standards and continue to serve the interests of investors.

Case Law on Client Mis-selling and Legal Liabilities

Mis-selling of financial products is a serious issue that has attracted increasing attention from regulators and courts in recent years. Both PRIIPs and MiFID II are designed to protect retail investors from being sold products that are not suitable for their needs or that they do not fully understand. However, the failure to adhere to these regulations can lead to significant legal consequences for firms, including financial penalties, compensation claims, and reputational damage.

Client Mis-selling Under PRIIPs

Under PRIIPs, firms have an obligation to ensure that the products they offer to retail clients are transparent and understandable. Mis-selling claims can arise if a client purchases a product without fully understanding its risks or costs. If a firm fails to adequately assess the target market or provide clear and accurate information, it may face legal action for mis-selling.

For example, a common mis-selling issue under PRIIPs is when firms fail to provide clear Key Information Documents (KIDs), which outline the risks, costs, and potential returns of the product. If a firm fails to produce or provide an accurate KID, retail investors may not have the information needed to make an informed investment decision. In such cases, regulators may intervene, and the firm could face legal challenges and claims for compensation from affected investors.

Mis-selling Under MiFID II

MiFID II includes detailed provisions to prevent the mis-selling of investment products, particularly by requiring firms to ensure that products are suitable for the investors they are sold to. If a firm fails to assess the suitability of an investment product for a client or if it provides advice that is not in line with the client’s needs, the firm can be held liable for mis-selling.

A key area where MiFID II addresses mis-selling is through the suitability and appropriateness tests that firms must conduct before offering investment products to retail clients. These tests involve gathering information about the client’s investment objectives, risk tolerance, and financial situation. If a firm fails to properly assess a client’s needs or recommends a product that is not suitable, it can be subject to enforcement action by regulators and legal claims from investors.

The European courts have seen several cases related to MiFID II and client mis-selling, and the legal liabilities for firms found guilty of mis-selling can be severe. Compensation for clients who were sold unsuitable products is one potential consequence. Firms can also face financial penalties, and their reputation can be severely damaged.

Case Law on Legal Liabilities

In recent years, there have been several notable cases related to mis-selling under PRIIPs and MiFID II. In these cases, courts have found that firms were liable for selling investment products to clients who did not fully understand the risks involved or who were sold products that did not match their investment objectives.

One key example is the case of an investor who was sold a high-risk product that was not suitable for their risk profile, as required by MiFID II. In this case, the court ruled that the firm had failed to meet its suitability obligations under MiFID II and ordered the firm to compensate the investor for their losses. The case set a precedent for how mis-selling claims would be treated under MiFID II and reinforced the importance of proper risk assessments and client disclosures.

In the context of PRIIPs, cases have arisen where investors have been sold complex investment products without receiving adequate explanations of the risks and costs involved. In some instances, firms have been found to be in violation of PRIIPs transparency rules, particularly the requirement to provide clear KIDs. These cases have reinforced the need for firms to adhere to strict product governance obligations to avoid legal liabilities.

Conclusion

Product governance under PRIIPs and MiFID II plays a crucial role in ensuring that investment products are designed, distributed, and managed in a way that protects investors and meets regulatory standards. By assessing target markets, ensuring transparency, and regularly reviewing products, firms can reduce the risk of mis-selling and ensure compliance with these regulations.

The legal consequences of mis-selling can be severe, including financial penalties, compensation claims, and reputational damage. As case law continues to evolve, investment firms must remain vigilant and ensure they meet their obligations under both PRIIPs and MiFID II. Adhering to the principles of product governance not only helps protect clients but also safeguards firms against potential legal risks.