There are two aspects that firms need to address, namely challenge and the PROD rules.

Challenge
The FCA identified that firms that demonstrated good practice had research and due diligence as a central function of the advice process, clearly showed they had the client’s best interests at heart and put this into practice.

A key driver of good research and due diligence was a corporate culture of challenge. The better firms had challenge built in to the process and/or individuals who were knowledgeable, enthusiastic and who challenged the firm’s approach. Where there was no culture of challenge within the firm, the research and due diligence process showed weaknesses.  We believe that firms and investment committees should be evidencing constructive challenge in their investment process.

PROD
Once firms have undertaken the ‘Research’ identifying which DFMs and Platforms they wish to use, and have carried out ‘Due Diligence’ on the selected DFMs and Platforms to ensure they meet the criteria set, they will need to drill down further with regard to the due diligence on the underlying funds to ensure that they are suitable for the target market.  Again, challenge to anything that looks ‘out of kilter’ will need to be evidenced.  Firms need to ‘get comfortable’ with the funds included within its solutions or consider not using them.

A key point to remember is that, prior to MiFIDII, the regulatory pronouncements on research and due diligence were mostly in the form of guidance. PROD carried that guidance forward, added some new requirements and framed it all as rules. We know the FCA have monitoring of adherence to PROD rules on the radar and we know that failure to satisfy the PROD rules has already figured in some supervisory notices leading to firms being prohibited from doing any new business. We would expect to see a thematic project at some point. At time of writing, some commentators have suggested that fewer than 5% of firms are properly complying with PROD rules. 

The principle PROD requirements for distributors (PROD 3.3.1) can be summarised as follows:

A distributor is required to: 

1. understand the financial instruments its distributes to clients;
2. assess the compatibility of the financial instruments with its clients’ needs;
3. take into account the manufacturer’s identified target market of end clients; and
4. distribute only when this is in the best interests of the client.

An example
If using DFM solutions, firms would need to have PROD data that identifies clients that are compatible with a DFM solution. So, the process would be: 

1. Is client compatible with a DFM solution?
2. If yes, which DFMs match the client type criteria.
3. Periodically, undertake DD on the DFMs used.
4. Finally, keep under regular review to identify relevant market changes.