From 1st January 2013 the AFM starts its actual supervision of product development. Suppliers of products have to have adequate procedures and measures at their disposal, which guarantee that the interests of the consumer, client or beneficiary of the financial product are taken into account in a balanced way. In addition, the relevant procedures and measures are also expected to be periodically applied to products offered or available in the market.
Therefore the market must look for a new balance between risks, return and client’s interests. In this framework the product approval procedure (PAP) plays an important role.
The knowledge of and experience in the market and in supervision can be found back in the requirements financial institutes will have to meet from 1st January 2013, according to Article 32 Bgfo. But in the build-up to the article in the Bgfo the AFM has not been sitting around doing nothing. Instead it has evaluated the PAP of several suppliers while executing its supervision.
The legal framework
In 2012 the AFM already pretested a number of institutions to establish how the PAP is dealt with in the market. From 1st January the actual supervision of product development by the AFM will start. In the hyperlink you will find the (concept) text of the modified Bgfo Article 32.
The development
Although only from the 1st January 2013 an article will be dedicated to the PAP in the legislation, these procedures have already been taken into account by supervisors for a number of years now. Therefore most suppliers already have this procedure functioning, providing them with the necessary experience.
In the framework of the theme Focus on Client’s Interest the AFM has already shaped the way it tests products with the ‘CUSC-criteria’. When products really want to focus on the interests of the client, they will have to meet with the starting points of Cost efficiency, Use, Security and Clarity.
| Cost efficiency: | Is the product good value for money? |
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| Use | Does the product fit a founded need of a target group? |
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| Security | Does the product do what it promises in different circumstances and is the result acceptable for the target group? |
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| Clarity | Can the target group evaluate the action of the product based on the information they receive from the supplier? |
The PAP should not only aim at the initial development of a product or service. The AFM recognises that the interests of the client tomorrow can differ from those today due to changing market conditions and changes in society. Circumstances change and norms do too. Suppliers are expected to continue testing their products during the life-span of those products.
It may seem as if it is the sole purpose of the PAP to serve the client’s interests, but nothing is further from the truth. The EBA, the European Bank Authority, states that the PAP also needs to evaluate how the introduction of a product relates to the liquidity and solvability of the institution. In short, besides the evaluation of behavioural aspects, prudential aspects also need to be evaluated within the PAP.
PAP’ s review process
The Bgfo states that the supplier needs to have adequate procedures and measures at their disposal, which guarantee that the interests of the consumer, client or beneficiary of the financial product are taken into account in a balanced way. The starting point is that an existing or new product will be reviewed. While setting up the review process the following aspects will be taken into account:
| Reproducibility | The PAP has to be fixed in order to ensure that how the final product has been created or why the product has not been marketed is transparent. Considerations and discussions need to be fixed in order to make clear what is in the client’s interest and what not. |
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| Involved disciplines | The parties involved should in any case be fiscal/legal matters, compliance officer, risk management, marketing, finance and operations. For the majority of the suppliers legal (fiscal) matters, compliance and risk management will have a weighty opinion. |
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| Responsibility | The operationally responsible for the execution of a PAP-review is often the product or formula manager (the first line). The first line is responsible for the timely start of the PAP-process and the timely and adequate involvement of the disciplines in question. Good administrative, accounting and internal control procedures. |
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| Mode of review | The Bgfo has no requirements regarding form. Remarkable however are the differences within the PAP-process. There are suppliers who give their approval according to CUSC (cost efficiency, use, security, clarity), but then a review has to be presented to a meeting several times. This process is of course very thorough, but also time-consuming. A more efficient method is to address all CUSC-subjects integrally and to tune into the relevant disciplines. |
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| Decision-making | The results of the PAP-process are often presented in the form of a memorandum to a (steering) committee. In that case the memo contains a proposal, for instance an approval, as well as the opinions of relevant expert units. For balanced decision-making it is important that there are no restrictions or pressure exerted on the contents or the composition of the opinions of the expert units. |
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| Follow-up | AFM has indicated to expect a reproducible review process with discussions during the evaluation procedure that need to be laid down and planned actions that will come up for discussion in a new evaluation.
Further steps (i.e. points for improvement) will have to be turned into action lists, safeguarding that these steps will lead to visible adjustments. |
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| Periodicity | A usual cycle is a review once every 2 years. In practice however this leads to bottlenecks as regards to capacity. Therefore, a review cycle must be considered based on the CUSC-criteria and fitting for the risk profile of a certain product. |
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| Governance | The organisation and its surroundings change. Therefore it is important to regularly check the procedure the financial institution follows to evaluate and review new and existing products, in order to verify whether it still suffices. That is why the AFM considers it important to make an analysis to verify whether the product still fits the vision, strategy and annual plan of the organisation. |
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| Proportionality | During the review process the degree of complexity and impact of the financial product should be taken into account. These delineate the target group and the extent of the scenarios. |
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Subjects that must be covered in the review
When doing a PAP-review the following subjects will be taken into account (when relevant):
- Determination target group
- Determination client need
- Testing on product characteristics
- Aftercare and management
- Termination or change
- Distribution
- Application procedure
- Communication to the client
- Operational and ICT-support
- Strategy of the supplier
Determination target group
The risks of a product can only be estimated well when the target group is clearly formulated. A clear definition of the target group is a prior condition to prevent possible ‘mis-selling’ or to be able to spot it. The objective of the target group or the need of the target group will have to be tested by means of a thorough examination.
Elements that need to be established in the review memorandum include:
- To whom a product cannot be sold and how this is controlled. So if there is a non-target group, a part has to be dedicated to the non-target group, to whom it cannot be sold or advised.
- Whether the intended distribution channels are suitable for the specified target group.
- In case of several target groups the risks of a product must be analysed at target group level and the result needs to be incorporated in the memo.
- In the case of a ‘non-target group’, measures have to be defined to determine how to prevent selling a product to the ‘non-target group’ and/or how to establish this has not happened.
- In the review process there has to be an explicit answer to the question whether the target group is still accurately described.
- If possible the product can be compared to other similar products from other suppliers.
- When (periodically) reviewing an existing product the foregoing will also have to be re-evaluated and an analysis will have to be made to verify whether the target group still suffices and whether the product still has not been sold to clients outside the target group.
Determination client need
The supplier has to specify and standardise the concept ‘client need’. In addition the supplier will have to consider how to establish whether the client need still exists (for instance when a general survey is sufficient and when a more extensive analysis on the level of product characteristics is needed).
The AFM has communicated the following starting points regarding the determination of the client need as described in Article 32 Bgfo paragraph 2a:
- Has a specific need of each target group been determined?
- Has it been tested whether the product still meets the intended need of the specific target group?
- Has a comparison been made with other product types or variations meeting the same need? Has a calculation or scenario analysis been incorporated in this comparison?
- Has it been determined, by means of client panels or other methods, whether the product really meets the need the client expects it to or if a deception can be anticipated?
Testing on product characteristics
The functioning of a product needs to be tested with scenarios describing different situations, including extreme scenarios. The key question is: Is the product good value for money under all circumstances and is the result acceptable and explainable to the clients?
The AFM has communicated the following starting points regarding the determination of the client need as described in Article 32 Bgfo paragraph 2b:
- Has a calculation been made to what extent a different deposit yields enough?
- Has an analysis been made to verify whether the fiscal restrictions change and how this influences the product?
- Has an analysis been made to verify whether the exclusions, acceptation criteria and conditions of coverage correspond to the target group and are understandable and truthful?
- Have the different cost components of the product (costs of management, administration, funding etc) and the process (costs of commission, distribution and transaction etc) been taken into account?
- Has the functioning of several product characteristics such as guarantee and indexation been looked at and has it been determined to what extent these characteristics meet the CUSC-criteria?
- The product is compared regarding product characteristics with competitive products from other suppliers in order to determine the added value of the product.
- Has an analysis been made of the complexity of the product and whether the product has not become too complicated due to the addition of optional product characteristics?
Aftercare and management
When introducing a product the need for aftercare has to be taken into account. When a product has been introduced a standard aftercare and management phase should be set up, determining whether the introduction went well and whether adaptations are needed. There needs to be a link between the complaints procedure and the review of products. The suppliers decide how the product and process can be improved as a result of received signals such as complaints, terminations and renewals.
Terminations or transfers
Products that are not up to standard and are detrimental to the interests of the client need to be adjusted as quickly as possible or terminated. The AFM does not only expect the product to be adapted or terminated, but it also wants to see aftercare of the clients who purchased it.
In the ideal situation an analysis should be made of how the client can terminate the product, the costs of this and how the total amount is determined. A part of this analysis could be the selection of several scenarios when calculating for instance costs of interest loss.
Distribution
The distribution needs to guarantee that the product does not end up with a pertinently unsuitable target group. Not each product of service is suitable for a certain distribution channel. For possible distribution channels an evaluation needs to be made of their suitability for the intended target group.
During the evaluation aspects such as quality and skills of the advisors also have to be taken into account. Who can advise the product in question? Is the available information sufficient? Is the advice combined with software or forms and are these adequate and not (incorrectly) misleading, for instance? Does the way the advice is given fit the target group? Is the mode of communication understandable, clear and consistent? Does the communication have the intended effect on the interest of the client?
Application process
The application process must be logical and comprehensible without unnecessary steps; the acceptation policy states the right criteria to accept the intended target group.
Communication to client
The product information needs to be tuned to the client. In each review the product information will need to be evaluated. The communication must guarantee that clients get a fitting image of the risks attached to the product.
Some points of attention listed within this framework:
- Is the product information correct and not misleading? Does the product information meet the advertising rules?
- All means of communication, physical as well as online, have been analysed to verify whether they are clear and comprehensible. The ambition is to write the information down for retail clients in language level B1.
- An analysis has been made to verify whether the communication is consistent and clear in all media.
- An analysis has been made to verify whether the product specifications are well-explained and understandable.
- The communication need of the client has been mapped out during the term of the product, whether this need is fulfilled has been determined. Whether the contents (annual surveys, intended capacity, built-up capital) of the communication has the desired effect has also been determined.
When testing the communication it is recommended when the occasion arises, to use consumer panels to evaluate and determine the clarity of the product information.
Based on the communication/information provision of the supplier, the client and advisor should be able to see and evaluate the key elements of the product, such as returns, costs, risks and restrictions.
Operational and ICT support
The supplier needs to guarantee that the facilities surrounding the product are sufficient for the employees and clients in order to offer the product in the right way and to keep it appropriate for the client.
Questions that can be asked within this framework and addressed in the PAP-memo are:
- Can the product be administered?
- Can the product be well supported by systems?
- In case of a short-term solution: has the temporary process been described clearly enough and do-able for employees? Are there clear agreements about the transition and the evaluation for the long-term solution?
- Has client support also been guaranteed in the long-term?
- Is there enough support for the client and employees to test whether the product is still appropriate in the long run?
To conclude
Although Article 32 Bgfo makes demands on a PAP-process you may already have implemented, it is important that you evaluate now whether your existing process and approach meet with the requirements that will come into force on 1st January 2013. If you do not yet have a PAP-process you will still have to draw it up and implement it.
Have you already made an analysis whether you have to meet Article 32 Bgfo and what if you do? We can help you evaluating the analysis made or doing the analysis itself. Furthermore we like to think with you about the way you have to deal with the requirements of the PAP-process.
We can also play an (independent) role in your PAP-process. When executing PAP-reviews we support you for instance when evaluating whether the relevant subjects are incorporated (correctly) in a product review memo.
For more information please contact Charco & Dique at 020-4165403 or e-mail us at info@charcoendique.nl