Oversight of New Product Development

1. Oversight of New Product Development FIRMA Conference Phoenix April 17, 2007 Presented by George Lencyk

3. New Product Development Oversight • New Product introduction is critical for business growth and maintaining a financial institution’s competitive position • Successful introduction of products is important for clients, profitable for your firm and shareholders • Poorly designed products or even good products introduced without the proper oversight can produce disastrous consequences, turn away clients, produce losses and tarnish your reputation • Introduction of increasingly complex products requires senior management attention and robust oversight • Regulatory bodies have weighed in - OCC 2004-20 and NASD Guidance of 2005

4. Definition of a New Product • Totally new product, not previously offered, • Modification to existing product that materially alters risks or other core attributes, • Product offered in a new location or different regulatory regime, • Product offered to a new client base or via different channels, i.e., institutional product offered to high net worth or retail clients,

5. Definition of a New Product • Product offered in different currencies, • Product with a different underlying reference security or currency, • Product that has remained dormant for a defined period, e.g., one year

6. What are the critical elements of a sound New Product Oversight and Approval Process? • Clearly articulated New Product Approval Policy • Well understood definition of what constitutes a new product • Defined responsibilities for the business sponsor and functional oversight groups • Early engagement of all required review groups • Well understood process for review and approval

7. What are the critical elements of a sound New Product Oversight and Approval Process? • Thorough analysis of the product, including its purpose, risk and return, target client profile, infrastructure requirements and fee structure • Training • Post implementation monitoring and review • Performance assessment

9. What should a New Product Approval Policy address and direct? • Authorization to introduce new products • Definition of new product • Appointment of appropriate risk review functions • Approval process and formal committee • Review standards/questions to be addressed • Criteria for post implementation review • Maintenance of records • Communication to appropriate senior management governance committees as necessary

10. Early involvement by all parties in the approval process is key • Meet frequently with senior business sponsors to ensure you know what is planned, what is in the pipeline • There is no substitute for walking around and hearing what is going on • At the outset, ensure that the product has the sponsorship of the appropriate senior business executive • Establish a prioritization process • A product manager, or senior product coordinator for each line of business should be designated to coordinate the development process • Product coordinator should engage the Risk Management Group at the beginning of the thought process and coordinate with each supporting discipline

11. Who should be part of the New Product Approval process? • Senior Business Sponsor • Risk Management • Legal • Compliance • Technology and Operations • Credit and Collateral Monitoring • Tax • Audit • Other disciplines, as necessary

12. New Product Reviewer Qualifications • New Product Committee should consist of functional heads or senior alternates • Senior function heads should not delegate their oversight role to more junior staff who may be “intimidated” by senior traders and product developers • Members of the new product oversight group must be highly qualified, well trained professionals willing to ask tough questions and appropriately challenge new product developers • Risk management should be the product expert and ensure the quality of the risk discussion

13. Questions that need to be addressed • What is the target client audience for this product? • What client need does this product satisfy? • What is the level of complexity and risk of loss? • What are the benefits of this product for the target market? • How does the product complement the existing offering set?

14. Questions that need to be addressed • Does the analysis provide the appropriate range of potential outcomes and illustrate the break even point? • What are the relevant tax issues around this product? Does the structure qualify for long term capital gains treatment? • Is the fee or cost structure of this product appropriate? • Any reputational issues? • Legal entity or jurisdiction issues?

15. Questions that need to be addressed • Any credit or collateral monitoring issues? • What is the expected volume? • Are there any incremental operational, systems, technology requirements? • Does valuation pose any issues? • Liquidity?

16. Questions that need to be addressed • Any issues with expiration or redemption? • How does this product impact other lines of business in your institution? • Capital requirements? • Does the documentation appropriately describe the product risks, and does it adhere to all local regulatory requirements? • What are the training requirements?

17. Variations and Documentation • Products that are variations on a current offering • May require differing degrees of scrutiny as necessary - but all relevant issues and questions must be addressed • Documentation • New product documents and approvals must be documented; Ideal format - database of product details and approvals

18. Heightened Risk Transactions • Transactions that may have complex, unusual features, lack transparency and have no purpose other than to achieve a particular accounting, regulatory or tax treatment • Transaction whose regulatory, accounting or tax treatment is uncertain • Transaction with a party whose reputation requires scrutiny • Require attention and escalation

19. One-off Approval Process • It may be appropriate to provide approval for a product for a specific circumstance • To accommodate specific one-time client need • To limit exposure until broader effort is anticipated • To control manual processes • Requires concentrated review effort, usually in shorter timeframe • Requires discipline to ensure that all relevant risk, regulatory, operational and related questions are addressed in the context of a narrow offering • Must be appropriately documented • Avoid expansion of wider use until full approval is provided

20. Marketing Guidelines • Determine positioning for client portfolios • Establish performance benchmark to determine success criteria • Identify target client base • Establish suitability criteria • Ensure accuracy and completeness of product disclosure

21. Training • Formal training session for all marketers • Must cover essential product characteristics, including payoff profile, and investment context • Document attendance

22. Post Product Implementation • New offerings should be monitored after launch and reviewed formally within an appropriate timeframe, e.g., six months. • A post implementation review should answer the following: • Is the product essentially the same as it was when approved? • Any operational problems? • Performance issues? • Client complaints? • Any regulatory issues since the product launch? • Volumes in line with expectations?

23. New Product Guidelines – NASD Notice to Members – April 2005 • Reminds firms of obligation to have written procedures to ensure thorough vetting of products prior to introduction • “Written procedures should provide clear, specific and practical guidelines for determining what constitutes a new product…” • Ask the Right Questions • Initial Product Review • Formal Approval • Post Approval Review

24. OCC Bulletin 2004-20 • OCC Guidance on Risk Management of New, Expanded or Modified Bank Products or Services • Underscores need to perform thorough due diligence prior to introducing new products • Focuses on assessing risks, review with relevant functional areas, expertise to manage products and compliance with regulations • Risk Management Controls and Processes • Ensure Risk Management polices and processes are appropriate for controlling risks of new products • Develop and implement MIS systems to monitor adherence to objectives

25. OCC Guidance - continued • Performance Monitoring • Management should have appropriate performance and monitoring systems in place • Appropriate limits • Objectives and performance criteria to evaluate success and detect adverse trends • Third parties – New products or services obtained through third parties pose unique risks and require: • Thorough understanding of risks • Adequate due diligence • Ongoing oversight

26. Appendix • OCC Guidance on Risk Management of New, Expanded or Modified Bank Products or Services - OCC 2004-20 • NASD Guidance of 2005