Order on Product Approval Procedures

Order on Product Approval Procedures 1)

Pursuant to Section 96, paragraph 2, and Section 270, paragraph 1, of Act No. 1155 of 8 June 2021 on securities firms and investment services and activities, and Section 7, paragraph 6, and Section 26, paragraph 4, of the Act on financial advisors, investment advisors, and mortgage credit intermediaries, cf. Act Consolidation No. 379 of 2 April 2020, it is hereby stipulated:

Chapter 1 Scope and Definitions

Scope

Section 1. This Order applies to the following undertakings, subject to paragraphs 2-7:

1. Credit institutions, mortgage credit institutions, and securities firms that provide or perform investment services and activities as referred to in Annex 1 to the Act on securities firms and investment services and activities.

2. Management companies for alternative investment funds (AIFMs) and managers of alternative investment funds that provide investment services as referred to in Annex 1 to the Act on securities firms and investment services and activities.

3. Branches in this country of credit institutions and investment firms that have been granted permission to provide or perform investment services or activities with or without ancillary services in a country outside the European Union, with which the Union has not concluded an agreement in the financial sector.

Paragraph 2. Section 6, paragraph 3, Section 7, paragraph 2, and Sections 14-19 apply to investment advisors and financial advisors covered by the Act on financial advisors, investment advisors, and mortgage credit intermediaries.

Paragraph 3. Sections 4 and 14 apply to investment firms and credit institutions that have been granted permission to provide investment services or activities in another country within the European Union or in a country with which the Union has concluded an agreement in the financial sector, and which conduct business in this country through a branch or a tied agent established in this country.

Paragraph 4. Sections 4 and 14 apply to management companies that have been granted permission to provide investment services in another country within the European Union or in a country with which the Union has concluded an agreement in the financial sector, and which conduct business in this country through a branch.

Paragraph 5. Sections 4 and 14 apply to cross-border services involving investment services and activities with or without ancillary services provided in this country by investment firms and credit institutions that have been granted permission in a country outside the European Union, with which the Union has not concluded an agreement in the financial sector.

Paragraph 6. This Order does not apply when the investment services provided by an undertaking relate to bonds without any embedded derivatives other than a make-whole clause.

Paragraph 7. This Order does not apply when the financial instruments are exclusively marketed or distributed to eligible counterparties.

Definitions

Section 2. In this Order, the following definitions apply:

1. Undertaking: The undertakings referred to in Section 1, paragraphs 1-5.

2. Distributor: An undertaking that offers or recommends a financial instrument, a structured deposit, or a service to a customer.

3. Product Developer: An undertaking that creates, develops, or issues a financial instrument or a structured deposit, including when advising undertakings on the launch of new financial instruments or structured deposits.

4. "Make-whole clause": A clause intended to protect the investor by ensuring that the issuer, in the event of early redemption of a bond, is obliged to pay the investor holding the bond an amount equal to the sum of the net present value of the expected remaining coupon payments until maturity and the principal of the bond to be redeemed.

Chapter 2 General Requirements for Product Approval Procedures and Product Governance Arrangements

Section 3. A product developer shall establish and apply a procedure for the approval of a financial instrument or a structured deposit and significant modifications of existing financial instruments or structured deposits before these are offered to customers.

Paragraph 2. The product approval procedure shall be designed to reflect the potential risk to the customer from the use of the financial instrument or structured deposit and their complexity.

Section 4. A product developer shall ensure that the financial instruments or structured deposits are designed in such a way that they meet the needs of a defined target group of customers and ensure that the distribution strategy for the financial instruments or structured deposits is consistent with the defined target group.

Paragraph 2. The product developer shall take reasonable steps to ensure that the financial instruments or structured deposits are distributed to the defined target group.

Section 5. The product approval procedure shall specify a defined target group of customers for each financial instrument or structured deposit and ensure that all relevant risks for this target group are assessed and that the intended distribution strategy fits the defined target group.

Section 6. An undertaking shall establish and apply a product governance arrangement whereby the undertaking regularly, and taking into account factors that may significantly affect the potential risk of the product for the defined target group, reviews the financial instruments and structured deposits offered by the undertaking and assesses whether these products continue to meet the needs of the target group and whether the intended distribution strategy remains appropriate.

Paragraph 2. The undertaking shall regularly re-evaluate its product approval procedures and product governance arrangements, update them, and take appropriate measures so that the arrangements remain robust and fit for purpose.

Paragraph 3. Paragraphs 1 and 2 also apply to a distributor providing services in connection with the offering of or advice on financial instruments and structured deposits.

Section 7. A product developer shall make all relevant information about the financial instrument or structured deposit available to any distributor of the instrument or deposit, including information on appropriate distribution channels, the product approval procedure, and the assessment of the target group.

Paragraph 2. A distributor that offers or recommends a financial instrument or structured deposit that the distributor has not itself produced shall obtain and use the information referred to in paragraph 1 from the product developer.

Chapter 3 Special Rules for Product Developers

Organisational Requirements etc.

Section 8. A product developer shall ensure that:

1. the product developer's employees involved in the production of a financial instrument or structured deposit have the necessary qualifications to understand the characteristics and risks of the product in question,
2. the product developer's management body has actual control over the undertaking's product governance arrangement,
3. the product developer's compliance function monitors the development and periodic review of product governance arrangements to reduce the risk that the product developer fails to comply with its obligations under Chapter 2 and this Chapter, and
4. the compliance reports to the product developer's management body systematically include information on the financial instruments and structured deposits produced by the product developer.

Paragraph 2. A product developer that collaborates with others to produce a financial instrument or structured deposit shall draw up a list of the respective areas of responsibility of the parties in a written agreement.

Section 9. A product developer shall ensure that there are procedures to prevent, identify, and handle conflicts of interest in the production of a financial instrument or structured deposit.

Paragraph 2. In designing a financial instrument or structured deposit, the product developer shall ensure that the design of the financial instrument, including its characteristics, does not have negative effects on end customers or cause problems with market integrity by enabling the product developer to hedge or dispose of its own risks or exposure to the product's or deposit's underlying assets, if the product developer already holds the underlying assets for its own account.

Paragraph 3. The product developer shall analyse potential conflicts of interest and in particular assess whether the financial instrument or structured deposit creates a situation where negative effects may arise for end customers if they:

1. are exposed in the opposite direction to the exposure that the product developer previously held itself, or
2. are exposed in the opposite direction to the exposure that the product developer intends to hold after the sale of the product.

Paragraph 4. Before launching the financial instrument or structured deposit, the product developer shall assess whether the instrument or deposit will threaten the orderly functioning or stability of financial markets.

Definition of Target Group

Section 10. A product developer shall define a target group at a sufficiently detailed level for each financial instrument and structured deposit and specify the types of customers whose needs, characteristics, and investment objectives the financial instrument or structured deposit is compatible with.

Paragraph 2. In its assessment, the product developer shall, among other things, investigate whether the risk and return profile of the financial instrument or structured deposit is consistent with the target group's risk and return profile, and whether the design of the instrument or deposit is motivated by elements that are in the customer's interest and not by a business model that relies on poor customer outcomes to be profitable.

Paragraph 3. A product developer producing financial instruments or structured deposits that are distributed via other undertakings shall carry out the target group definition and assessment referred to in paragraphs 1 and 2, based on the product developer's theoretical knowledge of and previous experience with the instrument or deposit or similar products, the financial markets, and the needs, characteristics, and investment objectives of potential end customers.

Paragraph 4. If several product developers collaborate on the production of a financial instrument or structured deposit, it is only necessary to define one target group for the relevant instrument or deposit.

Paragraph 5. The product developer shall also define any group of customers whose needs, characteristics, and investment objectives the product is not compatible with.

Fee Structure

Section 11. A product developer shall consider a fee structure for the financial instrument or structured deposit that ensures at minimum that:

1. the costs and fees for the instrument or deposit are compatible with the target group's needs, investment objectives, and characteristics,
2. the fees do not undermine the expected return of the instrument or deposit, and
3. the fee structure for the instrument or deposit is sufficiently transparent to the target group.

Scenario Analysis

Section 12. A product developer shall conduct a scenario analysis of its financial instruments or structured deposits with a view to assessing the risk of poor outcomes for end customers that the instrument or deposit may cause, and the circumstances under which such outcomes may occur.

Paragraph 2. The product developer shall assess the product based on negative scenarios, cf. paragraph 1, including in relation to the following circumstances:

1. Market conditions deteriorate.
2. The product developer or a third party involved in the construction or functioning of the instrument or deposit is subject to financial difficulties, or other counterparty risks materialise.
3. The instrument or deposit is not commercially viable.
4. Demand for the instrument or deposit is much higher than expected, putting pressure on the product developer's resources or on the market for the underlying instrument.

Ongoing Assessment of Financial Instruments or Structured Deposits

Section 13. A product developer shall regularly review the financial instruments or structured deposits that the product developer constructs, taking into account events that may materially affect the potential risks for the defined target group. The product developer shall in this context assess whether the product continues to meet the target group's needs, characteristics, and investment objectives, and whether it is distributed to customers whose needs, characteristics, and objectives are not compatible with the product. The product developer determines the frequency of the assessment based on relevant factors, including the complexity and innovative nature of the investment strategies used.

Paragraph 2. Notwithstanding paragraph 1, the product developer shall always re-evaluate a financial instrument or structured deposit before further issuance or relaunch of the instrument or deposit if the product developer has knowledge of events that may materially affect potential risks for customers. In this context, it shall be assessed whether the financial instrument functions as intended.

Paragraph 3. The product developer shall identify key events that will affect the potential risks or the expected return of the financial instrument or structured deposit, including:

1. exceeding a threshold that will affect the instrument's or deposit's return profile, or
2. the solvency situation of certain issuers, whose securities or collateral may affect the performance level of the instrument or deposit.

Paragraph 4. If events as referred to in paragraphs 1-3 occur, the product developer shall take appropriate measures, which may include:

1. Providing all relevant information about the event and its consequences for the financial instrument or structured deposit to customers or to distributors of the instrument or deposit, if the product developer does not itself offer or recommend the product directly to customers.
2. Changing the product approval procedure.
3. Ceasing further issuance of the financial instrument or structured deposit.
4. Changing the financial instrument or structured deposit to avoid unfair contractual terms.
5. Assessing whether distribution channels are appropriate if the product developer becomes aware that the financial instruments or structured deposits are not sold as planned.
6. Contacting the distributor to discuss a change in the distribution process.
7. Terminating the relationship with the distributor.
8. Informing the Danish Financial Supervisory Authority.

Chapter 4 Special Rules for Distributors

Section 14. A distributor shall understand the financial instruments or structured deposits and assess their fulfilment of the needs of the customers to whom the distributor provides investment services, including taking into account the defined target group.

Paragraph 2. The distributor shall ensure that it only offers or recommends financial instruments or structured deposits when this is in the customer's interest.

Organisational Requirements

Section 15. A distributor distributing financial instruments or structured deposits shall ensure that:

1. relevant employees have the necessary qualifications to understand the characteristics and risks of instruments or deposits that the undertaking offers or recommends, the services that the undertaking provides, and the defined target group's needs, characteristics, and objectives,
2. the distributor's management body has actual control over the distributor's product governance arrangement,
3. the distributor's compliance function monitors the development and periodic review of product governance arrangements to reduce the risk that the distributor fails to comply with its obligations under Section 5 and this Chapter, and
4. the compliance reports to the distributor's management body systematically include information on the products that the distributor offers or recommends and the services that the distributor provides.

Section 16. If several undertakings collaborate on the distribution of a financial instrument, structured deposit, or service, the undertaking that has the direct customer relationship has the ultimate responsibility for fulfilling the obligations set out in this Chapter on product approval and product governance, subject to paragraph 2.

Paragraph 2. An undertaking acting as an intermediary shall:

1. ensure that relevant product information is sent from the product developer to the distributor that has the direct customer contact,
2. make information available to the product developer about product sales for use in the product developer's compliance with its product governance arrangements, and
3. include product developers in the product governance obligations to the extent that this is relevant in relation to the service provided.

Definition of Target Group

Section 17. A distributor shall establish appropriate product governance arrangements to ensure that the financial instruments, structured deposits, and services that the distributor wishes to offer are compatible with the needs, characteristics, and investment objectives of a defined target group, and that the intended distribution strategy is consistent with the defined target group.

Paragraph 2. In the assessment, cf. paragraph 1, the distributor shall appropriately identify and assess the circumstances and needs of the customers that the distributor intends to focus on, so that customers' interests are not compromised as a result of commercial pressure or financing pressure.

Paragraph 3. The distributor shall define the target group for the relevant financial instrument or structured deposit, even if the target group is not defined by the product developer.

Paragraph 4. The distributor shall define any group of customers whose needs, characteristics, and investment objectives the financial instrument, structured deposit, or service is not compatible with.

Paragraph 5. The distributor shall re-evaluate the target group and/or update the product governance arrangements if it becomes clear that it has incorrectly defined the target group for a specific product or service, or if the product or service no longer matches the defined target group, e.g., if the product becomes illiquid or very volatile as a result of market changes.

Paragraph 6. A distributor that both produces and offers or recommends a financial instrument or structured deposit may only conduct one target group assessment.

Exchange of Information

Section 18. A distributor shall, for the purpose of defining the target group and distribution strategy for the financial instrument, structured deposit, or relevant service that the distributor wishes to offer or recommend, obtain information about the instrument, deposit, or service from product developers.

Paragraph 2. The distributor shall take all reasonable precautions to obtain appropriate and reliable information from other product developers than those referred to in paragraph 1, to ensure that the instrument or deposit is distributed in accordance with the target group's needs, characteristics, and investment objectives.

Paragraph 3. The distributor shall use information obtained in accordance with paragraphs 1 and 2 and the distributor's information about its own customers to define the target group and distribution strategy.

Section 19. A distributor shall make information available to product developers about sales and relevant information about the distributor's ongoing assessments.

Chapter 5 Penalties

Section 20. An undertaking that fails to comply with an order to perform or refrain from performing certain actions with a view to complying with the provisions of this Order shall be punishable by a fine.

Paragraph 2. Violations of Section 9, paragraph 2, shall be punishable by a fine.

Paragraph 3. Companies etc. (legal persons) may be subject to criminal liability in accordance with the rules of Chapter 5 of the Criminal Code.

Entry into Force

Section 21. This Order enters into force on 1 July 2021.

Paragraph 2. Order No. 922 of 29 June 2017 on product approval procedures is repealed.

Danish Financial Supervisory Authority, 25 June 2021 Jesper Berg / Sean Hove

1. The Order contains provisions implementing parts of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments (MiFID II), OJ EU 2014, No. L 173, p. 349, and Commission Delegated Directive 2017/593/EU of 7 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and the conditions for the issuance and reception of financial instruments and capital, product governance requirements and the rules applicable to the provision or receipt of fees, commissions or any monetary or non-monetary benefits, OJ EU 2017, No. L 87, p. 500, as well as parts of Directive (EU) 2021/338 of the European Parliament and of the Council of 16 February 2021 amending Directive 2014/65/EU as regards disclosure requirements, product governance and position limits, and of Directives 2013/36/EU and (EU) 2019/878, as regards their application to investment firms, with a view to contributing to recovery from the COVID-19 crisis, OJ EU 2021, No. L 68, p. 14.