PROD 3.1 General

Interpretation: financial instruments and structured products

PROD 3.1.1 R

1For the purposes of PROD 3, references to financial instruments include structured deposits.

Proportionate application of rules

PROD 3.1.2 R
  1. (1)

    A firm must, when manufacturing financial instruments or deciding on the range of financial instruments and investment services it intends to distribute to clients, comply, in a way that is appropriate and proportionate, with the requirements set out in this chapter.

  2. (2)

    In complying with these requirements, a firm must take into account:

    1. (a)

      the nature of the financial instrument or investment service; and

    2. (b)

      the target market for the financial instrument.

[Note: articles 9(1) and 10(1) of the MiFID Delegated Directive]

PROD 3.1.3 G

A proportionate application of the requirements in this chapter may mean that complying with the rules could be relatively simple for simple financial instruments distributed on an execution-only transaction basis where such financial instruments would be compatible with the needs and characteristics of the mass retail market.

PROD 3.2 Manufacture of products

General

PROD 3.2.1 R

1A manufacturer must:

  1. (1)

    ensure that the financial instruments it manufactures are designed to meet the needs of an identified target market of end clients within the relevant category of clients (see COBS 3 for client categories);

  2. (2)

    ensure that the strategy for distribution of the financial instruments is compatible with the identified target market; and

  3. (3)

    take reasonable steps to ensure that the financial instrument is distributed to the identified target market.

[Note: article 24(2) of MiFID]

PROD 3.2.2 G

Consideration of target market factors should permeate all aspects of product development and distribution, as well as ensuring the selection of appropriate distribution channels and the promotion of the financial instruments are accompanied by sufficient and correct information.

Product governance arrangements

PROD 3.2.3 R

A manufacturer must maintain, operate and review a process for the approval of:

  1. (1)

    each financial instrument, and

  2. (2)

    significant adaptations of existing financial instruments,

in each case before they are marketed or distributed to clients.

[Note: article 16(3) of MiFID]

PROD 3.2.4 R

For each financial instrument the product approval process must:

  1. (1)

    specify an identified target market of end clients within the relevant category of clients (see COBS 3 for client categories);

  2. (2)

    ensure that all relevant risks to the identified target market are assessed; and

  3. (3)

    ensure that the intended distribution strategy is consistent with the identified target market.

[Note: article 16(3) of MiFID]

PROD 3.2.5 G

When designing financial instruments, a firm should have in place systems and controls to manage adequately the risks posed by financial instrument design.

Manufacture by more than one firm

PROD 3.2.6 R

Where firms collaborate to manufacture a financial instrument, only one target market needs to be identified.

[Note: article 9(9) of the MiFID Delegated Directive]

PROD 3.2.7 R

Where firms collaborate, including with entities which are not authorised and supervised in accordance with MiFID or third countryinvestment firms, to create, develop, issue and/or design a financial instrument, they must outline their mutual responsibilities in a written agreement.

[Note: article 9(8) of the MiFID Delegated Directive]

Target market

PROD 3.2.8 R

Manufacturers must identify the potential target market for each financial instrument at a sufficiently granular level and must:

  1. (1)

    specify the type or types of client for whose needs, characteristics and objectives the financial instrument is compatible; and

  2. (2)

    identify any group or groups of client for whose needs, characteristics and objectives the financial instrument is not compatible.

[Note: article 9(9) of the MiFID Delegated Directive]

PROD 3.2.9 G

The level of granularity of the target market and the criteria used to define the target market and determine the appropriate distribution strategy should be relevant for the financial instrument and should make it possible to assess which clients fall within the target market. For simpler, more common financial instruments, the target market could be identified with less detail while for more complicated financial instruments such as bail-inable instruments or less common financial instruments, the target market should be identified with more detail.

[Note: recital 19 of the MiFID Delegated Directive]

PROD 3.2.10 R

Manufacturers must determine for each financial instrument they manufacture, whether it meets the identified needs, characteristics and objectives of the target market, and in doing so must include an examination of the following elements:

  1. (1)

    whether the financial instrument’s risk/reward profile is consistent with the target market; and

  2. (2)

    whether the design of the financial instrument is driven by features that benefit the client and not by a business model which relies on poor client outcomes to be profitable.

[Note: article 9(11) of the MiFID Delegated Directive]

PROD 3.2.11 R

Manufacturers of financial instruments that are distributed through other firms must determine the needs and characteristics of the clients for whom the product is compatible based on:

  1. (1)

    their theoretical knowledge of, and past experience with, the financial instrument or similar financial instruments;

  2. (2)

    the financial markets, and

  3. (3)

    the needs, characteristics and objectives of potential end clients.

[Note: article 9(9) of the MiFID Delegated Directive]

Product testing

PROD 3.2.12 R

Manufacturers must undertake a scenario analysis of their financial instruments to assess:

  1. (1)

    the risks of poor outcomes for end clients posed by the financial instrument; and

  2. (2)

    in which circumstances those poor outcomes may occur.

[Note: article 9(10) MiFID Delegated Directive]

PROD 3.2.13 R

In conducting the scenario analysis manufacturers must assess their financial instruments under negative conditions covering what would happen if, for example:

  1. (1)

    the market environment deteriorated; or

  2. (2)

    the manufacturer or a third party involved in manufacturing and/or the functioning of the financial instrument experiences financial difficulties or other counterparty risk materialises; or

  3. (3)

    the financial instrument fails to become commercially viable; or

  4. (4)

    demand for the financial instrument is much higher than anticipated, putting a strain on the firm’s resources and/or on the market of the underlying financial instrument.

[Note: article 9(10) MiFID Delegated Directive]

PROD 3.2.14 R

Manufacturers must consider the charging structure proposed for each financial instrument, including examination of the following:

  1. (1)

    whether the financial instrument’s costs and charges are compatible with the needs, objectives and characteristics of the target market;

  2. (2)

    whether the charges undermine the financial instrument’s return expectations, such as where the costs or charges equal, exceed or remove almost all the expected tax advantages linked to a financial instrument; and

  3. (3)

    whether the charging structure of the financial instrument is appropriately transparent for the target market, such as that it does not disguise charges or is too complex to understand.

[Note: article 9(12) of the MiFID Delegated Directive]

PROD 3.2.15 R

Manufacturers must consider whether the financial instrument may represent a threat to the orderly functioning, or to the stability, of financial markets before deciding to proceed with the launch of the financial instrument.

[Note: article 9(4) of the MiFID Delegated Directive]

Information disclosure to distributors

PROD 3.2.16 R

A manufacturer must make available to any distributor of that financial instrument:

  1. (1)

    all appropriate information on the financial instrument;

  2. (2)

    all appropriate information on the product approval process;

  3. (3)

    the identified target market of the financial instrument, including information about the target market assessment undertaken;

  4. (4)

    information about the appropriate channels for distribution of the financial instrument;

and must ensure that the information is of an adequate standard to enable distributors to understand and recommend or sell the financial instrument properly.

[Note: article 16(3) of MiFID II and 9(13) of the MiFID Delegated Directive]

PROD 3.2.17 G

When providing information to distributors, a manufacturer should make it clear if that information is not intended for end client use.

PROD 3.2.18 G

Manufacturers may consider, for example, with regard to each distribution channel or type of distributor what information distributors of that type already have, their likely level of knowledge and understanding, their information needs and what form or medium would best meet those needs (which could include discussions, written material or training as appropriate).

Review of financial instruments

PROD 3.2.19 R
  1. (1)

    A manufacturer must regularly review the financial instruments it manufactures taking into account any event that could materially affect the potential risk to the identified target market.

  2. (2)

    In doing so, a manufacturer must assess for each financial instrument at least the following:

    1. (a)

      whether the financial instrument remains consistent with the needs, characteristics and objectives of the identified target market;

    2. (b)

      whether the intended distribution strategy remains appropriate;

    3. (c)

      whether the financial instrument is being distributed to the target market; and

    4. (d)

      whether the financial instrument is reaching clients for whose needs, characteristics and objectives the financial instrument is not compatible.

[Note: article 16(3) of MiFID II and article 9(14) of the MiFID Delegated Directive]

G

In carrying out the reviews in PROD 3.2.19Rmanufacturers should collect and analyse appropriate management information to detect patterns in distribution as compared with the planned target market in order to assess the performance of the distribution channels through which a financial instrument is being distributed.

PROD 3.2.21 G
  1. (1)

    When reviewing the financial instruments it manufactures, a firm should communicate to the end client contractual “breakpoints” such as the end of a long tie-in period that may have a material impact on the end client that the end client cannot reasonably be expected to recall or know about already.

  2. (2)

    If the manufacturer does not know the identity of the end client, it should communicate any contractual breakpoints to the distributor.

PROD 3.2.22 R

Manufacturers must:

  1. (1)

    review financial instruments prior to any further issue or re-launch if they are aware of any event that could materially affect the potential risk to clients; and

  2. (2)

    identify crucial events that would affect the potential risk or return expectations of the financial instrument.

PROD 3.2.23 G

Crucial events that would affect the potential risk or return expectations of the financial instrument include:

  1. (1)

    the crossing of a threshold that will affect the return profile of the financial instrument; or

  2. (2)

    the solvency of certain issuers whose securities and guarantees may impact the performance of the financial instrument.

PROD 3.2.24 R

When a crucial event affecting the potential risk or return expectation of the financial instrument occurs, a manufacturer must take appropriate action, which may consist of:

  1. (1)

    the provision of any relevant information on the event and its consequences on the financial instrument to the clients or distributors of the financial instrument if the manufacturer does not offer or sell the financial instrument directly to the clients;

  2. (2)

    changing the product approval process;

  3. (3)

    stopping further issuance of the financial instrument;

  4. (4)

    changing the financial instrument to avoid unfair contract terms;

  5. (5)

    considering whether the sales channels through which the financial instrument is sold are appropriate where the manufacturer becomes aware that the financial instrument is not being sold as envisaged;

  6. (6)

    contacting the distributor to discuss a modification of the distribution process;

  7. (7)

    terminating the relationship with the distributor; or

  8. (8)

    informing the relevant competent authority.

R

Manufacturers must review financial instruments at regular intervals to assess whether they function as intended.

R

Manufacturers must determine how regularly to review their financial instruments based on relevant factors including factors linked to the complexity or the innovative nature of the investment strategies pursued.[Note: article 9(15) of the MiFID Delegated Directive]

Conflicts of interest

PROD 3.2.27 R

Manufacturers must establish, implement and maintain procedures and measures to ensure the manufacture of financial instruments complies with the requirements on proper management of conflicts of interest (see SYSC 10.1.7R), including remuneration.

PROD 3.2.28 R

Manufacturers must ensure that the design of each financial instrument, including its features, does not:

  1. (1)

    adversely affect end clients; or

  2. (2)

    lead to problems with market integrity by enabling the firm to mitigate and/or dispose of its own risks or exposure to the underlying assets of the product where the firm already holds the underlying assets on own account.

[Note: article 9(2) of the MiFID Delegated Directive]

PROD 3.2.29 R

Each time a financial instrument is manufacturedmanufacturers must analyse potential conflicts of interests.

PROD 3.2.30 R

In analysing potential conflicts of interest manufacturers must assess whether the financial instrument creates a situation where end clients may be adversely affected if end clients take:

  1. (1)

    an exposure opposite to the one previously held by the manufacturer itself; or

  2. (2)

    an exposure opposite to the one that the manufacturer wants to hold after the sale of the product.

[Note: article 9(3) of the MiFID Delegated Directive]

Oversight and training requirements

PROD 3.2.31 R

Manufacturers must ensure that their management bodies have effective control over their product governance process.

PROD 3.2.32 R

The development and periodic review of product governance arrangements must be monitored by the person allocated the compliance oversight function of a firm in order to detect any risk of failure by the manufacturer to comply with applicable provisions of PROD.

[Note: article 9(6) and article 9(7) of the MiFID Delegated Directive]

PROD 3.2.33 R

All relevant staff involved in the manufacturing of financial instruments must possess the necessary expertise to understand the characteristics and risks of the financial instruments they intend to manufacture.

[Note: article 9(5) of the MiFID Delegated Directive]

PROD 3.2.34 G

Firms should have regard to SYSC 5.1, and in particular SYSC 5.1.5AB R, when considering whether their relevant staff have the necessary expertise.

Compliance reports

PROD 3.2.35 R

Compliance reports to the management body must include information about the financial instruments that the firm has manufactured, including information on the distribution strategy.

PROD 3.2.36 R

Manufacturers must make the compliance reports available to their competent authority on request.

[Note: article 9(6) MiFID Delegated Directive]

PROD 3.3 Distribution of products and investment services

General

PROD 3.3.1 R

1A distributor must:

  1. (1)

    understand the financial instruments it distributes to clients;

  2. (2)

    assess the compatibility of the financial instruments with the needs of the clients to whom it distributes investment services, taking into account the manufacturer’s identified target market of end clients; and

  3. (3)

    ensure that financial instruments are distributed only when this is in the best interests of the client (see COBS 2.1.1R(1)).

[Note: article 24(2) of MiFID]

PROD 3.3.2 G

A distributor should consider what impact the selection of a given manufacturer could have on the end client in terms of charges or the financial strength of the manufacturer, or possibly, where information is available to the distributor, how efficiently and reliably the manufacturer will deal with the distributor or end client at the point of sale (or subsequently, such as when queries/complaints arise, claims are made, or a financial instrument reaches maturity).

Obtaining information from manufacturers

PROD 3.3.3 R

Distributors must obtain from MiFIDmanufacturers information to gain the necessary understanding and knowledge of the financial instruments they intend to distribute in order to ensure that the financial instruments will be distributed in accordance with the needs, characteristics and objectives of the target market.

[Note: article 16(3) MiFID and article 10(2) MiFID Delegated Directive]

PROD 3.3.4 G

In ensuring that they have obtained sufficient information about the financial instruments they distribute and in ensuring they understand the financial instruments or investment servicesdistributed, distributors:

  1. (1)

    should consider whether they understand the materials provided by the manufacturer or distributor earlier in the sales chain;

  2. (2)

    should ask the manufacturer to supply additional information or training where this seems necessary to understand the financial instrument or investment service adequately;

  3. (3)

    should not distribute the financial instrument or investment service if they do not understand it sufficiently; and

  4. (4)

    when providing information to another distributor in a distribution chain, should consider how the further distributor will use the information, such as whether it will be given to end clients. Firms should consider what information the further distributor requires and the likely level of knowledge and understanding of the further distributor and what medium may suit it best for the transmission of information.

Distributing financial instruments manufactured by non-MiFID firms, including third country firms

PROD 3.3.5 R
  1. (1)

    Distributors must take all reasonable steps to comply with PROD 3.3 when distributingfinancial instrumentsmanufactured by any firm to which MiFIDmanufacturer product governance requirements (PROD 3.2 or equivalent requirements of another EEA State) do not apply.

  2. (2)

    As part of this, distributors must put in place effective arrangements to ensure that they obtain sufficient, adequate and reliable information from the manufacturer about the financial instruments to ensure that they will be distributed in accordance with the characteristics, objectives and needs of the target market.

  3. (3)

    This rule applies to financial instruments sold on either the primary or secondary market.

PROD 3.3.6 R

The obligation to obtain adequate and reliable information applies proportionately depending on:

  1. (1)

    the degree to which publicly available information is obtainable; and

  2. (2)

    the complexity of the financial instrument.

[Note: articles 10(1) and 10(2) of the MiFID Delegated Directive)

PROD 3.3.7 R

Where information relevant to the obligation in PROD 3.3.5R is not publicly available, distributors must take all reasonable steps to obtain such relevant information from the manufacturer or its agent.

PROD 3.3.8 G

Acceptable publicly available information is information which is clear, reliable and produced to meet regulatory requirements, such as disclosure requirements under the transparency rules or the prospectus rules.

[Note: article 10(2) of the MiFID Delegated Directive]

Target market and distribution strategy

PROD 3.3.9 R

Distributors must determine the target market for the respective financial instrument, even if the target market was not defined by the manufacturer.

[Note: article 10(1) of the MiFID Delegated Directive]

PROD 3.3.10 R

Distributors must identify the target market and their distribution strategy using:

  1. (1)

    the information obtained from manufacturers; and

  2. (2)

    information they have on their own clients.

PROD 3.3.11 G

In identifying the target market and creating a distribution strategy, distributors should consider:

  1. (1)

    the nature of the financial instruments to be offered or recommended and how they fit with end clients’ needs and risk appetite;

  2. (2)

    the impact of charges on end clients;

  3. (3)

    the financial strength of the manufacturer; and

  4. (4)

    where information is available on the manufacturer’s processes, how efficiently and reliably the manufacturer will deal with the end client at the point of sale or subsequently, such as when complaints arise, claims are made or the financial instrument reaches maturity.

PROD 3.3.12 G

The target market identified by distributors for each financial instrument should be identified at a sufficiently granular level.

PROD 3.3.13 G

Where a distributor is part of a distribution chain, the information referred to in PROD 3.3.10R(2) should include information on the intended end client.

PROD 3.3.14 R

Where a firm acts both as a manufacturer and a distributor, only one target market assessment is required.

[Note: article 10(2) of the MiFID Delegated Directive]

PROD 3.3.15 R
  1. (1)

    Distributors must have in place adequate product governance arrangements to ensure that:

    1. (a)

      the financial instruments and investment services they intend to distribute are compatible with the needs, characteristics and objectives of the identified target market; and

    2. (b)

      the intended distribution strategy is consistent with the identified target market.

  2. (2)

    Distributors must appropriately identify and assess the circumstances and needs of the clients they intend to focus on to ensure that their clients’ interests are not compromised as a result of commercial or funding pressures.

  3. (3)

    Distributors must identify any groups of end clients for whose needs, characteristics and objectives the financial instrument or investment service is not compatible.

[Note: article 10(2) of the MiFID Delegated Directive]

PROD 3.3.16 R

Distributors must periodically review their product governance arrangements under PROD 3.3.15R and must take appropriate actions where necessary to ensure they remain robust and fit for their purpose.

[Note: article 16(3) of MiFID and article 10(4) of the MiFID Delegated Directive]

PROD 3.3.17 G

In the design of investment services, to help clients make an informed investment decision, firms should consider the support clients need before they reach the product selection part of the process.

PROD 3.3.18 R

Distributors must have in place procedures and measures to ensure that when deciding the range of financial instruments and investment services to be distributed, and the target market, all applicable rules are complied with, including but not limited to:

  1. (1)

    disclosure (see COBS 4 and COBS 14.3A);

  2. (2)

    suitability (see COBS 9A);

  3. (3)

    appropriateness (see COBS 10A);

  4. (4)

    inducements (see COBS 2.3A); and

  5. (5)

    conflicts of interest (see SYSC 10.1).

PROD 3.3.19 G

Distributors should take particular care to ensure compliance with PROD 3.3.18R when they intend to distribute new financial instruments or there are variations to the investment services they provide.

[Note: article 10(3) of the MiFID Delegated Directive]

Oversight and training requirements

PROD 3.3.20 R

The development and periodic review of product governance arrangements must be monitored by the person allocated the compliance oversight function of a firm in order to detect any risk of failure by the distributor to comply with applicable provisions of PROD.

[Note: article 10(6) of the MiFID Delegated Directive]

PROD 3.3.21 R

The management body of a distributor must have effective control over the firm’s product governance process to determine:

  1. (1)

    the range of financial instruments the firm offers or recommends; and

  2. (2)

    the investment services provided to the respective target markets.

[Note: article 10(8) of the MiFID Delegated Directive]

PROD 3.3.22 R

All relevant staff must possess the necessary expertise to understand:

  1. (1)

    the characteristics and risks of the financial instruments that the firm intends to distribute;

  2. (2)

    the investment services provided by the firm; and

  3. (3)

    the needs, characteristics and objectives of the identified target market.

[Note: article 10(7) of the MiFID Delegated Directive]

PROD 3.3.23 G

Firms should have regard to SYSC 5.1, and in particular SYSC 5.1.5AB R, when considering whether their relevant staff have the necessary expertise.

Compliance reports

PROD 3.3.24 R

Compliance reports to the management body must include information about the financial instrumentsdistributed by the firm and the investment services provided.

PROD 3.3.25 R

A distributor shall make the compliance reports available to competent authorities on request.

[Note: article 10(8) of the MiFID Delegated Directive]

Post-sale review

PROD 3.3.26 R

Distributors must regularly review the financial instruments they distribute and the investment services they provide, taking into account any event that could materially affect the potential risk to the identified target market.

PROD 3.3.27 R

In carrying out the review in PROD 3.3.26R, distributors must assess at least:

  1. (1)

    whether the financial instrument or investment service remains consistent with the needs, characteristics and objectives of the identified target market; and

  2. (2)

    whether the intended distribution strategy remains appropriate.

PROD 3.3.28 R

If a distributor becomes aware that it has wrongly identified the target market for a specific financial instrument or investment service, or the financial instrument or investment service no longer meets the circumstances of the identified target market, it must take appropriate steps, including at least:

  1. (1)

    reconsidering the target market; and/or

  2. (2)

    updating its product governance arrangements.

PROD 3.3.29 G

A distributor may need to take action under PROD 3.3.28R in circumstances where the financial instrument becomes very illiquid or very volatile due to market changes.

[Note: article 16(3) of MiFID and article 10(5) of the MiFID Delegated Directive]

Information sharing

PROD 3.3.30 R

To support the reviews carried out by manufacturers under PROD 3.2.19R to PROD 3.2.26R, a distributor must provide to the manufacturer of each financial instrument it distributes:

  1. (1)

    information on sales; and

  2. (2)

    where appropriate, information on the reviews carried out under PROD 3.3.26R to PROD 3.3.28R.

PROD 3.3.31 G
  1. (1)

    Information on sales should include information on any sales made outside the target market.

  2. (2)

    In complying with PROD 3.3.30R it is not necessary to report every sale to the manufacturer. Distributors should provide the data necessary for the manufacturer to review the financial instrument and check that it remains consistent with the needs, characteristics and objectives of the target market defined by the manufacturer. Relevant information could include:

    1. (a)

      summary information of the types of clients;

    2. (b)

      a summary of complaints received; and

    3. (c)

      responses from clients to questions suggested by the manufacturer for the purposes of obtaining feedback from a client sample.

  3. (3)

    In determining when providing information on the reviews carried out under PROD 3.3.26R to PROD3.3.28R is appropriate, a distributor should have regard to the requirements on the manufacturer in PROD 3.2. Information on the reviews should be shared if the manufacturer requests it.

[Note: article 10(9) of and recital 20 to the MiFID Delegated Directive]

Responsibilities in chains of distributors

PROD 3.3.32 R
  1. (1)

    A firm which distributesfinancial instruments or investment services to end clients is responsible for ensuring that the obligations in this chapter are met in respect of any financial instrument or investment service it distributes to an end client.

  2. (2)

    A firm which distributesfinancial instruments to clients which are not end clients must, in addition to complying with the rules in this chapter, consider if they are also undertaking a manufacturing role and, if they are, also apply PROD 3.2.

PROD 3.3.33 R

A distributor which distributesfinancial instruments to other distributors must:

  1. (1)

    ensure that relevant product information is passed from the manufacturer to the final distributor in the chain; and

  2. (2)

    if the manufacturer requires information on product sales in order to comply with its obligations under PROD 3.2, enable them to obtain it.

[Note: article 10(10) of the MiFID Delegated Directive]