The design and distribution obligations (DDO) may have been deferred for six months, but they're not going away.
Product issuers and distributors still need to prepare for the commencement of this regime - now set for 5 October 2021.
So what do you need to do to prepare? This will depend on whether you're a product issuer or a distributor, or whether you're responsible for both of these functions.
The DDO regime
The DDO regime introduces a new approach to regulation, by moving away from relying on disclosure as the main form of consumer protection and introducing new measures to ensure that products are designed and distributed with consumers in mind. As ASIC states in Consultation Paper 325:
The regime seeks to rebalance - between consumers and industry - the onus for effecting good consumer outcomes, and avoiding poor ones, in the provision of financial products.
The DDO regime generally applies in relation to financial products issued to retail clients that require a disclosure document (PDS or prospectus) and also products that are not regulated under Parts 6D.2 or 7.9 of the Corporations Act 2001, but that are 'financial products' under the ASIC Act (including credit contracts and consumer leases). The regulations also extend the DDO to apply to IDPSs.
Certain products are excluded though, including fully paid ordinary shares, MySuper products, margin lending facilities and securities issued under an employee share scheme.
What do product issuers need to do?
When it comes to launching a new product, hopefully every product provider aims for their offering to comply with the existing regulatory framework. Apart from meeting this existing pre-requisite (which is more prescriptive for some financial products than others), the new DDO regime now brings into focus, the likely objectives, financial situation and needs of retail clients.
ASIC expects in relation to the DDO, that product issuers will maintain product governance frameworks, to provide for effective product governance across the lifecycle of financial products.
Amongst the new requirements, issuers and distributors will need to take reasonable steps that will, or are reasonably likely to, result in distribution of the financial product being consistent with the product issuer's corresponding target market determination.
Target market determinations
Under the DDOs, product issuers will be required to make an "appropriate' target market determination (TMD) for each of their financial products, before such products are distributed. The requirement applies to the issuer's new products and also its existing products, where those products continue to be offered after the commencement of the DDO.
What are the TMD content requirements?
The TMD must:
- Describe the class of retail clients that comprises the target market;
- Specify any conditions or restrictions on retail product distribution conduct;
- Specify events and circumstances that may reasonably suggest that the TMD is no longer appropriate (review triggers);
- Specify the maximum period of time from the start of the TMD to when the first review must be completed;
- Specify the maximum period of time from the start of the period after the first TMD is completed, to the completion of the second review;
- Specify the reporting period for reporting information about complaints;
- Specify the type of information the issuer needs to identify promptly, whether a review trigger or another event has occurred, which would reasonably suggest that the TMD is no longer appropriate and specify who must report the information to the issuer and in what time frame.
Review of the TMD
The TMD will also include review triggers, such as those circumstances or events that would reasonably suggest the TMD may no longer be appropriate. Importantly, they are a prompt to stop distributing the product until the TMD is reviewed.
Under the DDO, distributors have their own obligations. ASIC expects that distributors will maintain product governance frameworks, for the purpose of ensuring that the distributor complies with its design and distribution obligations.
Distributors must take reasonable steps that will, or are reasonably likely to, result in distribution that is consistent with the TMD for the financial product (the reasonable steps obligation). In many cases, the distributor should be able to obtain enough information about the consumer through the application process, to determine whether the consumer is in the target market.
In some cases though, the distributor will need to take the step of asking the consumer certain questions. However, distributors should not in these cases, give consumers the impression that the distributor has considered their personal circumstances.
It is worth noting that the law does contain an exclusion, whereby asking a person for information solely to determine whether they are in the target market for a financial product and informing the person of the result of that determination, does not in itself constitute personal advice.1
How does the DDO regime interact with an advisor's obligations in relation to the provision of personal financial product advice?
As you will be aware, financial advisers who provide personal advice are already under an obligation to take into account the consumer's personal circumstances and provide advice that is appropriate.
When providing personal advice to a client in relation to the relevant financial product and implementing that advice, advisers will not be taken to have failed to take reasonable steps that will, or are reasonably likely to, result in distribution of a financial product being consistent with the TMD2.
Having said that, ASIC does believe that financial advisers should consider the TMD for a financial product where they provide personal advice and in meeting their best interests duty.
DDO and responsible lending obligations
As the DDO regime applies to credit products, ASIC considers that issuers and distributors may benefit from developing compliance practices that are complimentary to both the DDO and responsible lending regimes. ASIC's current view is that the reasonable steps required by DDO do not require further steps to be taken by a distributor when assessing (for responsible lending purposes), the consumer's ability to comply with their financial obligations under the relevant contract.
However, this is not in itself an exclusion from DDO and issuers and distributors will need to give careful consideration to how they will meet the new requirements. Additionally, in the case of mortgage brokers, they will also need to separately comply with the new mortgage broker best interests duties (now deferred until 1 January 2021).
When Product Issuers are also distributors
Where product issuers deal directly with consumers, they too are considered to be distributors under the DDO regime. Distributors must take steps that will, or are reasonably likely to, result in its retail product distribution conduct being consistent with the target market determination.
Many issuers, such as responsible entities, superannuation trustees and IDPS operators already monitor and impose their own terms and conditions on licensees and authorised representatives who distribute their products. Apart from considering how DDO will affect those arrangements, those providers will also need to consider their own obligations as distributors, where they also deal directly with retail clients. These matters can become more complex where those product issuers appoint promoters to assist in the distribution of those products.
Statutory reporting - significant dealings that are not consistent with the TMD
The DDO will also have a statutory reporting component, where "significant dealings' in the product have taken place, which are not consistent with the TMD. Product issuers will need to notify ASIC of such dealings, as soon as practicable and in any case within 10 business days3.
Distributors will instead need to inform the person who made the TMD (the product issuer) as soon as practicable and in any case within 10 business days of becoming aware of such significant dealings in the product4.
So what do you need to do now?
The introduction of the DDOs and the requirement for issuers and distributors to maintain robust product governance frameworks will go some way towards addressing the serious compliance issues identified by the Financial System Inquiry and the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
As you work through the DDOs and set up your product governance frameworks, don't lose sight of the fact that it is about improving consumer outcomes. The DDOs increase responsibility for product issuers and distributors, in relation to any poor consumer outcomes resulting from their products and products they distribute.
We are developing DDO templates for our HN Hub subscribers who also have access to around 250 other policies, procedures and ongoing training tools.
1 Section 766B(3A) of the Corporations Act 2001.
2 Section 994E(3) of the Corporations Act 2001 and the definition of "excluded conduct" in s994A(1).
3 Section 994G of the Corporations Act 2001.
4 Section 994F(6) of the Corporations Act 2001.
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.