Phase 1: Distributor Governance
Designing effective distribution governance
In the UK, the FCA Consumer Duty has further enhanced the requirement for firms to understand and ensure an effective oversight of their distribution chain. This is not a new concept, with origins stemming back to the FSA’s 2007 ‘Responsibilities of Product Providers and Distributors’ (RPPD) and further enhanced through the Retail Distribution Review (RDR) in 2013, and the implementation of MiFID II Product Governance, implemented as PROD in the UK.
MiFID II became effective in 2018, however we believe the industry, in general, is not yet able to fully evidence that they have effective oversight of their distribution chain. At Devlin Mambo, we have been helping clients define their strategy, and build effective distribution governance frameworks across their global distribution network. The requirements are not limited to the UK and Europe, but a global approach to an oversight framework should be considered.
So, what do we mean by distribution governance?
At Devlin Mambo, we ensure our clients understand the difference between product governance, distributor governance, and distribution governance.
- Product Governance, from a regulatory perspective, is the act of ensuring systems and controls are in place across the product process to ensure that they meet legal and regulatory requirements. From a functional perspective, product governance is a key liaison between the product boards, committees, the asset manager, distributor and supplier which enables effective board oversight, conflicts of interest management, cross-business collaboration, prioritisation management etc etc.
- Distributor Governance ensures that you work with distribution partners that meet your expectations in the way they sell, or make your products available, throughout the distribution chain.
- Distribution Governance provides clarity to your distribution entity that distribution activity, from both your internal activity and your distribution partners, is appropriate. This includes ensuring the effective operation and control within the distribution function and supporting entities.
How can you establish effective distribution governance?
Distribution governance is not an overnight implementation and requires careful thought and strategic direction. From a practical perspective, we see a three-phase approach as optimal. In this blog, we focus on Phase 1 – building an effective distributor governance framework.
If you can answer the following three questions with a ‘yes’, or ‘we are in a good place’, then you can rightly move on to phase 2 – enhancing and evidencing distribution control. Unfortunately, to gain clarity to provide the right responses, is often extremely complex. As we have helped our clients through the process, we believe answering the following questions help shape an effective framework.
Question 1: Do you know who sells, or makes available, your funds?
This seems a relatively simple question, depending on your distribution model, however the complexity of an intermediated distribution chain may make this difficult to answer confidently. Many distributors use omnibus or nominee accounts, which mask the entities and types of clients that sit therein. In addition, one entity may have a direct holding on the fund register however they may have different client streams within that holding – for example, execution only retail, advised retail, and professional client channels within one platform distributor.
To answer the question, you need to have a good level of look-through to those holders on your register, their business and client type, and their distribution model for your products.
Question 2: Do you have an appropriate contract in place?
Once you have considered question one, you now need to ensure that the distribution relationship is governed appropriately. We would expect that appropriate distribution contracts are in place and controls are aligned to the product range, regulatory permissions and distribution strategy. This is a regulatory requirement, as well as good governance.
Practically speaking, it’s not always possible to put a contract in place with the end-distributor if there is no direct relationship. Considering distribution activity in the UK market, there could be anything up to 4, 5, or 6 layers before a product reaches an end consumer. Look-through may be difficult.
So, what is practical? As a distribution entity, you are accountable for appropriate distribution activity to the product board as a delegate. To ensure effective governance, as a minimum, a distribution contract should be in place with all direct distributors on the register – those who sell, or make available your products. Contracts should contain key clauses to ensure that onward distribution activity is appropriate and can be evidenced. Any sub-distribution activity should be tightly controlled to ensure your product continues to be represented appropriately. A good example is ensuring that negative target market sales and complaints information is passed back to the manufacturer, to feed into the product governance process.
Question 3: Are your products being represented as expected?
You know who sells your funds and you have a contract in place with them, but how do you evidence that your products are being represented appropriately throughout the relationship? The answer is effective KYD – i.e. Know Your Distributor.
KYD allows firms to develop a risk-based framework to assess how third-party distributors represent their products. Key questions are asked of distributors around the structure, governance arrangements, policies, controls, AML and KYC, sales practices and marketing approach. The aim is to assess the risk of distribution activity, ensure regulatory compliance, and ensure distribution strategies and marketing approach are aligned. The industry has developed standard questionnaires to help ensure consistency.
The framework should be proportionate to your distribution activity. Assessment of KYD should assign a distributor with a risk profile which should be documented from the initial KYD at onboarding and updated through the latest assessment. Higher risk distribution activity, more complex products, multiple jurisdictions, sub-distribution, proximity to retail clients, and other relevant factors may increase risk. Increased risk would require a more frequent assessment of the distributors control environment. Considerations should also be given to your product set and target clients when designing this proportionate framework.
We have noticed that several firms focus on answering question 3, prior to ensuring that answers to questions 1 and 2 are clear. Whilst this may help mitigate potential risk in distribution practices, there may be gaps in the universe of product distributors, and no contractual control with some entities. Answering the questions can, and should, be conducted simultaneously. Once answers and strategy are clear, an effective framework can be built.
The next logical step is phase 2 – enhancing and evidencing control. The key is designing reporting and MI for the product board and distribution entities to enable effective decision making. Product Boards and entities accountable for Distribution within the business require similar, yet differing, sets of M.I. to both satisfy their oversight requirements, assess risk, and challenge practices.
How can Devlin Mambo help?
We strongly believe there is no ‘one size fits all’ framework to ensure effective oversight of distribution activity. In helping our clients, whilst also helping shape the industry approach, we believe we have a rounded, practical offering to help solve this problem. For more information, please get in touch with a member of the team.