Product Governance for consumer loans, deposits, accounts and payment transactions

a) Overview

Product Governance requirements are familiar - from the MiFID II regulations for financial instruments. From 1 May 2024, new product governance rules will also apply to consumer loans, deposits, accounts and payment transactions.

On 30 October 2023, the German Federal Financial Supervisory Authority (BaFin) published a circular letter on the monitoring and governance of banking products in retail banking - Rundschreiben 08/2023. Based on Sec. 25a para. 1 of the German Banking Act (KWG) and 27 para. 1 of the German Payment Services Supervision Act (ZAG), BaFin is thus implementing the EBA Guidelines on product oversight and governance arrangements for retail banking products (EBA/GL/2015/18), published in 2015, into German supervisory practice.

b) Products covered (consumer business)

According to the BaFin circular letter, the product governance rules apply if the relevant products are offered to consumers. These are all natural persons who purchase the products for private purposes (Sec. 13 of the German Civil Code - BGB) and also business founders when acting for the purpose of starting a commercial or freelance activity (Sec. 513 BGB).

The new rules are to be applied to consumer loans, savings products, accounts and payment transactions; in detail to the following products:

• Real estate consumer loan agreements (Sec. 491 para. 3 BGB) with the exception of subsidised real estate loans (Sec. 491 para. 3 sentence 3 BGB),
• General consumer loan agreements (Sec. 491 para. 2 BGB),
• Deposits (Sec. 2 para. 3 sentence 1, 2 EinSiG) with the exception of structured deposits (Sec. 2 para. 11 WpHG),
• Payment accounts (Sec. 1 para. 17 ZAG),
• Payment services (Sec. 1 para. 1 sentence 2 ZAG),
• Payment instruments (Sec. 1 para. 20 ZAG),
• other means of payment such as travellers' cheques and bank cheques (in accordance with Annex 1 No. 5 of the Capital Adequacy Directive IV)
• and e-money (Sec. 1 para. 2 sentence 3 ZAG)

The product governance obligations apply to products that are newly launched on the market after 1 May 2024 and to products that are significantly modified after 1 May 2024.

c) Financial service providers addressed

The requirements must be observed by product manufacturers and product distributors.

Product manufacturers are all CRR credit institutions, payment institutions and e-money institutions which design the relevant products, i.e., create, develop, combine, or significantly change them. Product distributors are considered manufacturers if they are involved in the design of the product.

Product distributors are all companies that offer or sell the covered products to consumers.

d) Obligations of manufacturers

The main objective of the new product governance is consumer protection. For BaFin, product governance ensures a responsible and sustainable manufacturing and distribution process for financial products that is less focused on maximising company profits and more focused on the interests of the consumer.

It is therefore central to the new rules that manufacturers must define a target market for each relevant product and that the product must appear suitable for the interests, objectives, and characteristics of the respective target market. Products whose features, costs and risks do not correspond to the interests, objectives, and characteristics of the respective target market and which have no benefit for this target market may neither be designed nor launched on the market. The product manufacturer must carry out product tests before the market launch to show how the product would affect consumers in various scenarios, including stress scenarios.

For the market launch, the product manufacturer may select distribution channels only that are suitable for the target market. The selected product distributors must have sufficient knowledge, competence, and ability to properly introduce the product to the market and provide appropriate information explaining the product characteristics and risks to consumers.

To this end, the manufacturer must provide the product distributor with a description of the product, with clear, precise, and up-to-date information on the risks and the total price for the consumer.

After market launch, the manufacturer is obliged to continuously monitor the product to ensure that the interests, objectives, and characteristics of consumers are considered. Product distributors must also be monitored to ensure that the product is only sold in its target market and that the product distributor complies with the manufacturer's regulations for product monitoring and governance. For the manufacturers, this requires the inclusion of corresponding regulations in the distribution agreements.

If problems are identified, the product manufacturers must take remedial action. They are obliged to take the necessary countermeasures to limit the damage that has occurred and prevent further damage.

e) Obligations of product distributors

The new requirements for product monitoring and governance also place a duty on product distributors. They must set up, implement, and review policies that ensure that consumer interests are adequately taken into account when products are launched on the market, that potential harm to consumers is avoided, and that conflicts of interest are minimised. In particular, sufficient information about the target markets and information for consumers about the main characteristics of the product, its risks, and the overall price are required.

f) Organisation and documentation

BaFin expects product governance to be embedded in the new product process in accordance with (or corresponding to) AT 8.1 MaRisk. The supervision of the processes must be integrated into the usual tasks of the risk controlling function and the compliance function. Institutions must also integrate their regulations for product monitoring and governance into their framework for corporate governance and risk management as defined by (or in accordance with) MaRisk. These regulations and subsequent reviews have to be approved by the executive officers.

All measures taken for product monitoring and governance must be adequately documented. The documentation must be kept for at least five years for audit purposes and made available to Bafin on request.

g) Entry into force and preparation

Product manufacturers and product distributors must comply with the new product governance obligations specified in the circular from 1 May 2024. Even though many institutions have already incorporated a large proportion of the new requirements for the monitoring of loan, deposit, account, and payment products into their new product processes, it will be necessary to extensively adapt the written rules and processes with the involvement of the executive officers. The documentation requirements will also become more extensive. Special attention must also be paid to the implementation in all distribution channels with with sales partners, where existing agreements must be adapted.