In the second half of 2018, BaFin conducted a market survey in relation to certain new conduct of business and organisational rules under the second European Markets in Financial Instruments Directive (MiFID II): 55 institutions were surveyed about product governance, among them 25 financial services institutions, five securities trading banks and 25 banks and savings banks. Thirty of the institutions responded in relation to the status of implementation of the MiFID II provisions on record-keeping obligations (taping), suitability statements and cost transparency. Of those 30, 25 were financial services institutions and five were securities trading banks.

Pause button used to stop taping

Generally speaking, the surveyed financial institutions and securities trading banks are complying with their record-keeping obligations (taping). They obviously succeeded to a large extent with technical implementation. However, the survey revealed that almost half of the surveyed institutions had set up a pause button to interrupt recording in order to exclude parts of the conversation from the recording. In addition, there were some isolated cases in which the record of the telephone conversation was limited to an inadequate summary recorded subsequently, while the actual conversation was not recorded on tape. No clients had objected to the recording of the conversation on any of the 11,505 tapes created in total during the survey period.

Cost comparison difficulties

BaFin's market survey showed that financial services institutions and securities trading banks have not yet developed a standard market practice for providing information on the composition and structure of costs and charges and the method of calculation. It is therefore difficult for clients to compare the information. Encouragingly, the vast majority of institutions present the costs and charges based on the amounts actually invested by clients, as do banks and savings banks. This is more customer-friendly than a calculation based on example figures. Furthermore, institutions voluntarily provide a level of detail about costs and charges that would only actually be necessary if requested by a client. On the downside, the evaluation of random samples revealed some incomplete and mathematically incorrect information of costs and charges. Some cost components required to be disclosed by law were also missing.

Formulaic statement of suitability

The suitability statement which is required to be prepared in conjunction with the provision of investment advice to retail clients played only a minor role in the market survey, because the surveyed financial services institutions and securities trading banks predominantly provide portfolio management services or advise professional clients. In the few business-to-customer cases in which suitability statements were required, they only rarely showed a complete match between the information provided by the client and the features of the recommended financial instrument. In many cases, the institutions relied solely on a formulaic statement indicating that the financial instrument matched the information provided by the client, defeating the actual purpose of the statement of suitability.

Product governance: facilitating target market identification

Two standards are of key relevance for the vast majority of banks, savings banks and financial services institutions when implementing product governance obligations:

• BaFin's "Circular 05/2018 (WA) – Minimum Requirements for the Compliance Function and Additional Requirements Governing Rules of Conduct, Organisation and Transparency" (MaComp), specifically BT 5;
• the Common Standard for the Determination of the Target Markets for Securities developed by the German Banking Industry Committee (GBIC), the German Investment Funds Association (BVI) and the Deutsche Derivate Verband (German Derivatives Association – DDV). This standard makes the process of identifying the target market, which is done by manufacturers (designers), and the processes of defining the target market and matching the client to the target market, which are done by distributors, considerably easier. The standard format also allows smooth communication between manufacturers and distributors and enables target market information to be integrated in WM Datenservice's database, which is used by numerous firms.

An important finding of the survey is therefore: thanks to standardisation, the determination and identification of target markets and the matching of clients to target markets is working well. In individual cases, however, the statements made in relation to certain target market categories were in need of improvement: it stood out, for example, how often "asset accumulation or optimisation" was stated as the investment objective, even though there are other pre-defined objectives such as making specific provisions for retirement. For some investment products, greater differentiation would have been desirable. However, BaFin expects that more shape will soon be given to the process of identifying the target market, for example as a result of the changes proposed as part of the European Securities and Markets Authority's (ESMA) consultation on integrating sustainability risks and factors in MiFID II (see BaFinJournal January 2019).

Negative target market and proportionality

BaFin will also continue to monitor developments in relation to negative target market identification and implementation of the principle of proportionality: only a minute number of manufacturers (and asset managers for investment strategies) identified a negative target market for their products. In addition, in some cases it was not apparent that manufacturers and distributors had shown any greater care in the course of product governance processes when particularly high-risk, complex or illiquid products were involved. They are, however, required by law to do so.

Finally, the market survey on product governance revealed that smaller institutions are finding it increasingly difficult to meet complex and extensive regulatory requirements in addition to carrying on their day-to-day business. By contrast, the larger firms considered it challenging to integrate the new processes within the framework of existing processes. For this reason, guidance at European level – such as ESMA’s product governance guidelines – and at national level – such as BaFin’s MaComp – is needed now more than ever before.