Reflections on the proposed design and distribution obligations and ASIC product intervention powers

In this article, we briefly outline the proposed design and distribution obligations and ASIC’s product intervention powers and offer some reflections on the issues arising particularly for product issuers.

Key points

  • The proposed design and distribution obligations will impose significant regulatory and compliance obligations on both product issuers and product manufacturers.
  • A key design obligation is prepare a target market determination, which essentially requires a the product manufacturer to make a judgment about product suitability for a class of retail clients to whom the product is intended to be issued or sold.
  • The ASIC product interventions powers aim at preventing or responding to significant consumer detriment in respect to certain financial products.
  • The proposed design and distribution obligations will be subject to a 2 year transition period, but the ASIC product intervention powers will commence the day after the Bill receives Royal Assent.
  • We consider that affected industry participants should be considering their obligations under this Bill, as it is likely that the Bill will pass Parliament in the near future.

Overview

The Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2018 (Bill) will:

  • amend the Corporations Act 2001 (Cth) (Corporations Act) to set out ‘design and distribution obligations’ on both product manufacturers and product distributors in respect of certain financial products; and
  • amend the Corporations Act and the National Consumer Credit Protection Act 2009 (Cth) (Credit Act) to introduce a ‘product intervention power’ for ASIC to prevent or respond to significant consumer detriment in respect to certain financial products.

In this article, we briefly outline the design and distribution obligations and ASIC’s product intervention powers and offer some reflections on the issues arising particularly for product issuers.

The Bill implements a recommendation of the 2014 Financial System Inquiry to introduce customer-targeted and principles-based product design for financial products and more stringent distribution obligations to overcome lack of consumer understanding because of inadequate disclosure, poor product design, and poor financial literacy.

Outline of the obligations

The design and distribution obligations on product offerers and product distributors are described below. Under the proposed regime, a product issuer may also be the distributor of the product. The obligations generally apply to offers of financial products that require disclosure under the Corporations Act (i.e. a PDS or prospectus).

Obligations on product issuers Obligations on distributors
Offerors must make a target market determination for most financial products that require disclosure. Distributors are prohibited from distributing a product unless a current target market determination is in place.
Offerors must make target market determinations available to the public free of charge.
Offerors must develop a plan for reviewing target market determinations and abide by that plan. Distributors must not distribute a product where a target market determination may no longer be appropriate.
Offerors must notify ASIC of any significant dealings in a product that are not consistent with the product’s target market determination Distributors must notify a product’s offeror of a significant dealing in a product that is not consistent with the product’s target market determination.
Offerors must specify distribution information that distributors must collect, keep and provide back to the offeror. Distributors must provide to offerors numbers of complaints about the product and distribution information relating to the product that offerors have specified.
Offerors and distributors must take reasonable steps so that distribution is consistent with the most recent target market determination.
Offerors and distributors must maintain records and information relating to their obligations under the new regime.

ASIC enforcement powers and civil action

In addition to the above, ASIC will be given powers to enforce the new arrangements, including the ability to request necessary information, issue stop orders and make necessary exemptions and modifications to the new arrangements.

Further, under the Bill, a person who suffers loss or damage because of a contravention of the design and distribution obligations would be able to recover that loss by civil action.

Target market determinations

A key design obligation is that an issuer is required to make a ‘target market determination’ for their product.

For the target market determination to be appropriate for the product being issued or sold, it must be reasonable to conclude that:

  • it would be likely that the retail client is in the target market; and
  • an issue or sale of the product would likely be consistent with the likely objectives, financial situation and needs of the retail client.

These two considerations will require product developers to think about their potential customer. These considerations do not require an issuer to have knowledge about individual consumers, and it is not intended to be personal advice. The factors (being likely objectives, financial situation and needs), which are important when personal advice is provided to a customer, must be considered at the product development stage, and when considering to whom the product will be marketed and the distribution channel. They are challenging requirements because on the one hand they are not intended to constitute personal advice yet, on the other hand, the legislative wording uses the language of personal advice.

A target market determination must be in writing, describe the class of retail clients that comprise the product’s target market, specify conditions and restrictions on distribution of the product, specify events that would deem the determination to be no longer appropriate and provide determination review and reporting periods and the information required to consider whether the determination is still appropriate.

The target market determination must be reviewed periodically and on the occurrence of trigger events. Offerors must maintain records of their decision making processes for making the target market determination, setting review triggers and periods and other required information. If an offeror becomes aware of any significant dealings that are not consistent with the target market determination, they must notify ASIC within 10 business days, in writing.

Implications of needing to formulate target market determinations

Offerors will need to consider who their retail customers are, and implement a methodology to determine the suitability of products for that market. Product approval procedures must be changed. Broad target markets will require a more comprehensive analysis of the requirements of the class of retail consumers who could form part of the target market, which could result in some changes to the product, or the offering of certain products to some consumers on different terms.

Product manufacturers may need to undertake further market research on matters such as consumer behaviour and microeconomic conditions, and in a practical sense may need to outsource this to work to professional third party consultants.

Manufacturers of products involving alternative investments, such as hedge funds, may find it particularly challenging to formulate a target market determination. However, retails clients should be given access to these investment classes and should have their access restricted on the basis of the regulatory burden imposed on manufacturing and distribution channels by the proposed legislation.

The compliance and regulatory burden of the target market determination requirement may be somewhat eased if industry templates are formulated. Industry templates will also assist with standardization, which can serve as a useful tool for investors making product comparisons.

Implications of the distribution obligations

The distribution obligations apply in respect of ‘retail product distribution conduct’. This is, in relation to a product, dealing in relation to a retail client, providing financial product advice to a retail client, or giving a disclosure document or PDS to a retail client.

The requirement that reasonable steps are taken so that retail product distribution conduct is reasonably consistent with the target market determination will mean that offerors and distributors will need to adopt risk management methodologies to ensure that the risk associated with inappropriate distribution of a product that might cause harm to a customer is minimized or eliminated. The Bill states that a person will not be taken to have failed to take reasonable steps if the retail product distribution is inconsistent with the target market determination, or if a retail client who is not in the target market acquires the product. Notwithstanding this, we expect that this protection may not be as helpful as it seems. Rather, we think ensuring the consistency of the distribution of product with the target market determination will be very important, and will require considerable thought and work by offerors and distributors.

The target market determination will be included in promotional material, advertisements or published statements (or customers referred to where the determination may be found).

ASIC product intervention powers

The Bill provides ASIC with the powers to proactively intervene in relation to financial and credit products by making orders to prohibit specified conduct related to the product.  The intervention power applies to products regulated under the Corporations Act and Credit Act. In relation to products regulated under the Corporations Act, the power generally only applies in an ‘issue situation’ and where a product may be made available to retail clients. The intervention power can be used regardless as to whether or not the financial product requires disclosure under Corporations Act.

The new intervention power can be used where ASIC is satisfied that a product or class of products has resulted, or is likely to result, in significant detriment to relevant persons. The term ‘significant’ is not defined and is intended to take its ordinary meaning. However, the new law will provide non-exhaustive guidance by stating that relevant factors include the nature and extent of the detriment, including any actual or potential financial loss to consumers, and the impact that the detriment has had, or will or is likely to have, on consumers.

ASIC must consult affected parties before making the intervention orders and must make all orders public. A person who suffers loss or damage because of a contravention of the design and distribution obligations may recover that loss by civil action.

If ASIC decides an intervention order is required, it can be enforced for up to 18 months. With approval from the Minister, this can be extended. If a Court makes an order which is relevant to the intervention order, the period of the Court’s order is not to be included within the intervention order period.

Implications

The product intervention power gives ASIC a powerful weapon in its enforcement armoury. It also gives ASIC a new risk – that of being held accountable for products that have caused consumer loss where ASIC failed to prevent the issue of that product.

Transition period and progress of the Bill

The new design and distribution regime applies 24 months after this Bill receives the Royal Assent. The ASIC product intervention powers commence on the day the Bill receives Royal Assent.

On 20 September 2018, the Government introduced the Bill into Parliament. It was referred to the Senate Economics Legislation Committee, which produced a report on 9 November 2018. The Committee recommended that the Bill be passed, although Labour senators may recommendations for changes.

On 23 October 2018, the Government released for public consultation exposure draft regulations to support the Bill and a draft Explanatory Statement, the purpose of which is to enhance the design and distribution obligations and product intervention regimes by altering the products and persons in relation to which the design and distribution obligations regime applies and the products that may be subject to a product intervention order by ASIC.

General observations

The design and distribution obligations will impose significant regulatory and compliance obligations on both product issuers and product manufacturers. We consider that affected industry participants should be considering their obligations under this Bill, as it is likely that the Bill will pass Parliament in the near future. We would be pleased to assist you with developing your plans to deal with this significant development.

In some ways the policy rationale reflects that, in the mind of the policy-makers, the current legal and regime is insufficient to protect retail clients. There is, however, an evident regulatory shift from disclosure to retail investors (coupled with financial product advice from a professional adviser) as being a sufficient basis for decision-making for retail clients to ensuring that ‘bad’ or ‘inappropriate’ products are not sold to the ‘wrong’ persons – hence, a shift if you will from ‘caveat emptor’ to financial services firms acting as gatekeeper to minimize the risk of loss of investment by retail clients. It also suggests that financial advisers appear to have less importance in the financial services industry than previously expected. It is an open question as to whether this is where the regulatory pendulum should be swinging.


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