Following months of heightened scrutiny on target market determinations (TMDs) across the financial services sector, we are seeing signs that ASIC has shifted its focus on broader product and distribution governance under the DDO regime. In particular, ASIC has started issuing statutory notices and asking questions as part of a thematic review into how issuers and distributors are complying with their reasonable steps obligations.

Consistent with ASIC's latest 'enforcement first' approach to thematic reviews, we anticipate that ASIC will soon move to commencing targeted enforcement action (including stop orders and civil penalty action).

This shift in focus by ASIC under the DDO regime has been expected and demonstrates a strategic phasing of supervision and enforcement activity from ASIC under the DDO regime. In the first phase, ASIC focussed on lifting the overall standard on target market identification and distribution conditions in TMDs. Now with greater specificity in TMDs, the stage is set for ASIC to demand higher standards in compliance with reasonable steps obligations.

In this article, we focus on some of the key pressure points in DDO compliance as ASIC shifts its focus.

Key insights & predictions

  • "Reasonable steps" are broad and malleable: ASIC is likely to adopt a broad interpretation of what the reasonable steps obligation legally requires from issuers and distributors. The concept of what constitutes "reasonable steps" will also vary depending on the circumstances, such as the breadth or narrowness of the target market, the product type, product risk and complexity, distribution channels, customer composition and sector. Where the product is distributed using mass marketing, more will be expected of distributors in terms of reasonable steps, to demonstrate that interested investors are filtered and are likely to be in the target market. This broad and malleable approach would be premised on the broad ambit of the obligation, as specified in section 994E(5) of the Corporations Act, as well as the object of Chapter 7 of the Corporations Act to promote the provision of suitable financial products (see section 760A of the Corporations Act).
  • Specificity and tailoring, rather than standardisation: ASIC is likely to question generic distribution monitoring and compliance arrangements that rely on standardised, one-size-fits-all analysis for reviewing the appropriateness of TMDs, distribution conditions and target market definition and test their appropriateness having regard to variations between the TMDs for the products distributed.
  • Need for quantitative data: We anticipate that ASIC will use statutory notices to require issuers and distributors to provide a significant volume of granular quantitative data with respect to product design and distribution, including, for example, with respect to pricing, conversion rates, cancellation rates, complaints, and any other data used to inform decision-making for product design and distribution. We are already seeing this approach from ASIC in a number of sectors.
  • Need for tangible evidence: As part of the thematic review, issuers and distributors who receive a statutory notice from ASIC may find it difficult in practice to respond to directions to provide required information, particularly in response to directions which require specific documented evidence of steps taken to comply with the reasonable steps obligation. It will also be important to demonstrate how the evidence and quantitative data translates and feeds into the qualitative decision-making of the issuer or distributor.
  • Greater scrutiny on distribution of riskier and complex products: Issuers of relatively high risk and complex products should be prepared to answer questions from ASIC to justify the issuer's determination that it is appropriate for the product to be distributed through a general advice or information-only (i.e. non-advised) channel. When this occurs, we anticipate that it would be vital to substantiate how the product is being distributed in a targeted way towards retail clients who are in the target market including by the use of additional reasonable steps in the distribution process.
  • Legal professional privilege: When obtaining legal advice on the reasonable steps obligation and in response to any statutory notice from ASIC, prudent issuers and distributors will implement a protocol to ensure the appropriate identification and preservation of legal professional privilege.
  • Importance of review of and uplift to product and distribution governance: To mitigate the risk of enforcement action (including stop orders) and its consequences including business interruption and reputation damage, prudent issuers and distributors will be taking steps now to review, uplift and document their product distribution (including product marketing) and product governance arrangements including for example in relation to their use of questionnaires. This is a considerably more involved process, requiring more planning, time and resources, as compared to the uplifting of TMDs that occurred during ASIC's first phase of DDO surveillance and enforcement.

The pressure points

We anticipate that issuers and distributors will be required to address questions with respect to whether their product governance and distribution arrangements are adequate and consistent with their reasonable steps obligation.

We anticipate that this will potentially include the following questions and areas of focus:

Approval of distribution and marketing arrangements
  • It is relatively common practice across the industry for TMDs to require distribution arrangements to be specifically approved by the issuer. The premise behind this distribution condition is that the issuer would only approve arrangements that are likely to result in the product being issued to retail clients who are likely to be in the target market.
  • Where a TMD includes such a requirement:
    • Does the issuer or distributor have a documented framework for assessing proposed marketing material and distribution channels (including sales scripts) for consistency with the TMD?
    • Is this assessment sufficiently robust and effective, and does it specifically explain why the issuer reasonably considers that the proposed distribution arrangement is likely to lead to the product being issued to retail clients who are likely to be in the target market?
    • Are these assessments documented?
Review triggers
  • In certain sectors, the majority of TMDs contain a review trigger which is enlivened when product performance is materially inconsistent with expectations, by reference to specified factors.
  • Where a TMD includes such a requirement:
    • Does the issuer have pre-determined and documented numerical thresholds for the level of product performance (e.g. cancellation rates, complaints, profitability) that would be inconsistent with expectations?
    • How were these thresholds identified?
    • Is there a documented assessment which explains how these thresholds were identified, and how these thresholds help the issuer verify that the product continues to meet the appropriateness requirements in section 994B(8)?
Suitability of distribution arrangements
  • Has the issuer assessed on a regular basis whether the chosen distribution channels and distribution conditions are consistent with the appropriateness requirements in section 994B(8)?
  • Is there a documented process with respect to how this assessment should be performed? Is this assessment supported by data?
  • Are these assessments documented?
Notification and record keeping obligations for distributors
  • Sections 994F(6) and 994G contain notification obligations which are triggered when an issuer or distributor becomes aware of a significant dealing that is 'not consistent' with the TMD.
    • Does the issuer or distributor have documented guidance on how representatives can practically identify where a dealing to a retail client is inconsistent with the TMD and escalate difficult assessments?
    • Do representatives have a practical understanding of how they would identify a dealing that is inconsistent with the TMD? For example, does this include both a dealing in breach of a distribution condition, as well as a dealing to a retail client who is outside the target market?
  • Does the issuer or distributor have a documented procedure on how representatives should identify and record complaints in relation to retail product distribution conduct in respect of a product or a product's performance, which includes having regard to Privacy Act considerations? Do representatives have a practical understanding of how to identify and record such a complaint?
  • Does the issuer or distributor have a documented process for reconciling general complaints data with complaints relevant to the issuer's design and distribution obligations for a specific product?
  • Does the issuer have a documented and objectively ascertainable threshold of what would constitute a significant dealing?
  • What information does the distributor keep with respect to documenting the steps it has taken to meet its reasonable steps obligation? Is this information sufficiently detailed, or is it limited to information about compliance with the distribution conditions?
TMD reviews
  • Does the issuer have documented evidence that it has conducted regular TMD reviews and completed them in the required review periods?
  • Is the analysis in the TMD review sufficiently detailed to give the issuer a reasonable basis to conclude that the continued use of the existing distribution arrangements and distribution conditions remains consistent with the appropriateness requirement in section 994B(8) and has this analysis been appropriately documented?
  • Does the analysis in the TMD review specifically address the substance of any complaints received over the review period and whether they indicate that the TMD may no longer be appropriate?
  • Does the issuer have a documented process for performing and documenting assessments with respect to whether the TMD continues to be appropriate after changes to product design, product distribution or changes to law?
Monitoring and oversight
  • Does the issuer or distributor have a documented understanding of the monitoring and oversight steps that would be appropriate for it to undertake to comply with its reasonable steps obligation?
  • Does the issuer have records of the positive steps it has taken to verify whether its distributors are complying with distribution conditions and meeting their own reasonable steps obligations"?
  • Was it reasonable for the issuer to take steps, and has the issuer taken steps, against distributors that failed to provide reporting information in a manner consistent with its reasonable steps obligation, having regard to the broad factors in section 994E(5)?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.