“I came in like a wrecking ball
Yeah, I just closed my eyes and swung”
— Hon Josh Frydenberg MP, Revised Explanatory Memorandum for Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 (or Miley Cyrus “Wrecking Ball”).
Obligations and Interventions
Considering the deluge of regulatory reform bearing down on licensees and advisers, it’s not surprising that the Design and Distribution Obligations (D&D) have largely been overlooked.
That’s a mistake, because although they won’t be one of the “most significant reforms of financial services since FSRA”, they will create an environment in which product issuers (and not advisers) will bear primary responsibility for product failures and mis-selling.
That’s not to say that Licensees and advisers aren’t also affected, but the best interests duty (and related obligations) mean that they are spared most of the impact of these changes.
So, although you might consider that the D&D Obligations are largely a matter for the product issuers, you still need to understand your obligations and the scope of the new regime.
SUMMARY: The new regime created by the Design and Distribution Obligations Act:
- Encompasses design, issue, distribution, intervention and enforcement;
- Requires a Product Issuer to prepare a Target Market Determination (TMD) for each product;
- Requires a Distributor to take reasonable steps to comply with the TMD;
- Requires a Distributor to track, record and escalate any breaches or complaints.
“Although these losses have a number of contributing causes, poor product design and distribution practices that disregard consumer behavioural biases and information asymmetries played a significant role.” Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019. ”
— Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019. Revised Explanatory Memorandum. 3.8
The new product design and distribution regime per Pt 7.8A of the Corporations Act 2001 commencing on 5 October 2021, will apply to issuers and distributors of financial products.
For issuers, the obligations apply to persons who must prepare a disclosure document under the Corporations Act; for example, a Responsible Entity, an Insurer, a Superannuation Trustee, and an Issuer of hybrid securities.
For Distributors, the obligations apply to anyone engaging in “retail product distribution conduct”; for example, dealing in a financial product, giving a disclosure document, providing a PDS or providing financial product advice.
Essentially, the design and distribution obligations impose requirements at each stage of developing and distributing a financial product from:
The regime encompasses many of the financial products with which you may deal, but it specifically excludes a:
- MySuper product; or
- Margin lending facility; or
- Security that has been or will be issued under an employee share scheme; or
- Fully paid ordinary share in a company or a foreign company; or
- Financial product issued, or offered for regulated sale, by an exempt body or an exempt public authority; or
- Financial product of a kind prescribed by regulations.
Read DDO Act
Target Market Determinations
Perhaps the core of this new regime is the requirement that most, if not all, financial products marketed to retail clients will have a Target Market Determination – a written statement from the Issuer that confirms the people, or classes of people, for whom the product may be appropriate.
Think of the TMD as a less immediately useful movie classification scheme for financial products – except one where the Studios classify their own films.
The Target Market Determination prepared (and maintained) by the Issuer must:
- Describe the class of consumers that comprises the target market for the product;
- Specify any distribution conditions and restrictions on distribution;
- Specify review triggers (events that reasonably suggest the TMD is no longer appropriate);
- Specify when the first review of the TMD must occur;
- Specify when subsequent reviews of the TMD must occur;
- Specify reporting periods for when distributors should provide information about the number of complaints about the product to the issuer; and
- Specify the kinds of information the distributors must report to the issuer (and how frequently).
The Issuer’s Obligations
In the new regime, Issuers have a range of obligations beyond developing, administering and marketing financial products. Specifically, they must:
- Prepare a Target Market Determination (TMD) for the financial product that meets all the requirements (Including the ‘content and appropriateness requirements’);
- Make the TMD publicly available—this applies to both new and continuing products;
- Take reasonable steps that will, or are reasonably likely to, result in distribution being consistent with the TMD;
- Review the TMD to ensure that it remains appropriate;
- Notify ASIC of significant dealings that are not consistent with the TMD; and
- Keep records of the decisions made (including the data and analysis underlying those decisions) in relation to compliance with the design and distribution obligations.
The Distributor’s Obligations
We mentioned previously that anyone providing personal advice is already subject to a range of requirements, obligations and prohibitions (including Appropriateness, Best Interests and Client Priority) that govern their conduct in respect of product distribution.
For this reason, advisers are broadly (but not entirely) excluded from the more onerous requirements of the regime. That’s not to suggest that they are entirely spared, because their authorising Licensees assume additional obligations that inevitably trickle-down to impact their representatives.
For example, Licensees must take reasonable steps to:
- ensure that their product distribution methods (marketing, promotion and recommendations) reflect, and are consistent with, the most recent TMD for that product;
- notify an Issuer as soon as practicable (within 10 business days) if they become aware of a significant dealing in the product that is not consistent with the TMD; and
- keep complete and accurate records of distribution information (including the number of complaints received about a product and information specified by the issuer in the TMD).
Licensees will need to incorporate these additional requirements in their compliance framework and, consistent with the nature, scale and complexity of their business, reflect them in their approach to adviser monitoring and supervision.
If this appears to be a passive obligation, take the time to appreciate that Licensees have an ongoing obligation to ensure their distribution method is appropriate. In ASIC’s view, this means a governance framework that regularly considers:
- their compliance with the Issuer’s conditions;
- their distribution method;
- their Marketing and Promotional materials;
- the effectiveness of product governance and distribution oversight;
- the appropriateness of any ‘sales’ incentives;
- the training provided to their representatives; and
- the Target Market Determinations.
Revised Explanatory Memorandum
- Review your Approved Product List (and Research methodology);
- Incorporate the consideration of the TMD into your advice process;
- Review your monitoring and supervision framework;
- Review your Marketing and Promotion Guidelines;
- Review your risk appetite; and
- Train your advisers and support staff.
“The combination of civil and criminal penalties allows ASIC or the prosecutor (as the case may be) to take a proportional approach to enforcing the new obligations.”
— Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019. Revised Explanatory Memorandum
While these reforms may neither significantly impact advisers or their advice processes, don’t underestimate either your obligations to comply or the significant costs of non-compliance.
Non-compliance can have a significant cost with penalties for contraventions ranging between $11,100 to $44,000 for individuals or from $55,000 to $222,000 for Corporations. In addition, some contraventions can attract penalties of imprisonment for terms from 12 months to five years.
There’s not much Licensees or Advisers can do about this beyond acknowledging that, since April 2019, ASIC’s had the power to proactively, and pre-emptively intervene in respect of financial and credit products that risk causing significant detriment to consumers or are “misaligned with their needs, understanding or expectations”.
In practical terms, where ASIC consider that a financial product or a class of financial products may be mis-sold, misrepresented or cause significant detriment, ASIC can make:
- an individual order that applies to a specific person(s) in relation to a product; or
- a market-wide order that is applicable to a person in relation to a class of product.
If this seems to be a broad power, it is, and necessarily so, and it’s not a theoretical risk but a power that ASIC have not hesitated to use.
For example, in September 2019 ASIC made their first product intervention order in respect of short term credit to protect consumers from predatory lending. Although challenged, this intervention was subsequently upheld by the Federal Court.
“We are pleased today’s judgment upheld our intervention order and the consumer protections it is designed to deliver. We will continue our efforts to protect vulnerable consumers, particularly during this time when significant numbers of people are facing uniquely challenging circumstances. We will move swiftly where we see high cost products that seek to exploit the day-to-day immediate needs of financially vulnerable consumers.”
— ASIC Commissioner, Sean Hughes 20-089MR
Broadly speaking, before intervening ASIC will consider:
- The nature and extent of the detriment or likely detriment;
- The actual or potential financial loss to retail clients;
- The impact that the detriment will have, or will or is likely to have on retail clients;
- Any other matter.