Dear CEO letter: CBI review of MiFID structured retail products

As highlighted in our previous publication, driving fair outcomes for consumers and investors, and for their interests to be at the centre of financial services, is an evergreen priority for the Central Bank of Ireland (CBI).  

The CBI has now written to MiFID investment firms, setting out its findings from a series of targeted reviews of structured retail products (SRPs) and its expectations of firms when implementing relevant MiFID II requirements. Both the CBI's key findings from its SRP reviews and its expectations of firms who manufacture, distribute or otherwise offer SRPs, are set out below. 

Findings and observations

The CBI identifies a number of poor practices and weaknesses in firms' SRP arrangements and controls, which increase risks to investors and include instances where firms have failed to:
identify a sufficiently granular target market

  • adequately consider the use of high complex features in SRPs being manufactured and distributed to retail clients, which may be difficult for these clients to understand
  • present fair and balanced past performance (back-testing) information, supported by appropriate context and narrative
  • display capital at risk warnings in prominent positions for products where the client's capital is at risk
  • ensure consistent levels of clarity and comprehensiveness in disclosures
  • disclose adequately the risk and potential impact of restructuring to clients prior to sale

Expectations

The CBI expects firms to adhere to high standards of investor protection, acting in the best interests of their clients at all times. The CBI expects firms' SRP arrangements and controls to keep pace with the increased complexity in the retail investment market, and the increased likelihood that retail clients may not fully understand the product or how the return is generated, and may misinterpret the level of capital protection and risk associated with their investment. Firms should be proactive and meticulous in ensuring that they do business in a way that protects clients when manufacturing and distributing SRPs. At a minimum, the CBI expects firms' governance processes to encompass the following:

  • Conducting an assessment of the target market in a proportionate manner, one that considers the nature and complexity of the product. The more complex the SRP, the more comprehensive and granular the target market assessment must be.
  • Where complex features are proposed, firms must consider if they are appropriate for the retail market and whether they are likely to be understood by the target market. The approval of the use of such features should be subject to robust governance and challenge, which should be clearly documented by the firm. In particular, the CBI highlights a 'decrement index' as one example of a complex SRP feature and sets out its expectation that the use of such complex features should be subject to robust governance and challenge to ensure they are justified and in clients' best interests.
  • Where past performance (back-testing) information is presented, firms must ensure that it is fair and balanced, supported by clear narrative and context, and does not diminish the potential likelihood of capital loss. Care must be taken to avoid presenting an overly-optimistic or unbalanced picture of the likely investor outcomes.
  • In the case of complex products such as SRPs, firms must take special care when designing and presenting marketing information to ensure that individual statements, as well as the tone and overall content when read together, remain fair, clear and not misleading.
  • In addition to providing clients with information that is fair, clear and not misleading, firms must ensure that information on financial instruments includes appropriate warnings of the risks associated with investing in those instruments. The CBI views transparency and effective disclosures as key to enabling investors to make informed investment decisions. This is particularly the case where the product or service is complex or where there are many similar types of products on the market.
  • Firms must ensure that capital at risk warnings are in a prominent location in all marketing communications and advertisements.
  • Firms must ensure the risk that a product may be restructured is disclosed to clients prior to sale.

Actions required

The CBI's expectation is that firms who manufacture, distribute or otherwise offer SRPs should review and make the necessary changes to their SRP arrangements and controls in light of the above-outlined expectations. In particular, firms are expected to:

  • Present the Dear CEO letter as a formal agenda item for discussion at the firm's next board meeting, and for the discussion to be recorded in the meeting minutes.
  • Undertake a full review of current SRP arrangements and controls against the findings and expectations outlined above, to include SRP design, manufacture and distribution, processes, procedures, training materials, templates and disclosures.
  • Document the review including, inter alia, details of actions taken or planned to address matters raised. This review should be completed and an action plan discussed and approved by the firm's board by Q3 2022. The action plan must include clear and reasonable timelines for implementation of mitigating actions with appropriate governance and sign off.

In addition, the CBI highlights that the expectations set out in the Dear CEO letter are not exhaustive. The CBI expects firms to continually evaluate the effectiveness of all arrangements and controls relating to the manufacture and distribution of SRPs to ensure that they are meeting the highest standards of investor protection and delivering fair outcomes that put their clients' interests to the fore.

Next steps

Firms who manufacture, distribute or otherwise offer SRPs must factor the above-outlined CBI expectations into their compliance risk frameworks and comply with the required actions. The above-outlined CBI expectations should also inform the SRP arrangements and controls of firms that commence the manufacture or distribution of SRPs in the future. 

In addition to the CBI's focus on driving fair outcomes for consumers and investors, there is a strong focus on retail investor protection at a European level, with the European supervisory authorities (ESAs) recently advising that retail investors are of particular concern, and that national competent authorities should monitor risks to retail investors, as highlighted in our recent article. The ESA's have also recently recommended significant changes to the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation, with the aim of improving the presentation of information provided to consumers and simplifying product comparison. The European Securities and Markets Authority (ESMA) has also made a number of recommendations to the European Commission to improve investor protection under MiFID II, focusing on disclosures, digital disclosures and digital tools and channels.

Regulated firms should factor both the CBI's and the ESA's focus on retail investor protection into their horizon scanning and compliance risk frameworks. To assist regulated firms in this regard, we shall publish further Insights on both the ESA's recommended changes to the PRIIPs Regulation and ESMA's recommendations to improve investor protection under MiFID II, together with further updates on this topic as they arise.

For further information in relation to this topic, please contact Patrick Brandt, Partner, Kevin Allen, Partner, Christopher Martin, Of Counsel, Sian Langley, Knowledge Lawyer or any member of ALG's financial regulation team.

Date published: 10 May 2022