ASIC’s DDO surveillance continues – eToro under fire for inadequate screening test
By Sean McMahon and Sarah Sherman
In a move highlighting ASIC’s continuing surveillance in the design and distribution space, the regulator recently commenced proceedings against eToro Aus Capital (eToro) for using a ‘wholly inadequate’ screening test to determine whether retail investors fell within the target market of its contract for difference (CFD) product.
Our recent Alert Analysis of ASIC report 762—your DDO health check, outlined the key points of ASIC’s report 762 and flagged the importance of product issuers meeting their design and distribution obligations (DDO).
We explain what you need to know about ASIC’s continuing surveillance.
What do you need to know?
- ASIC remains active in the DDO space.
- ASIC has shifted its surveillance focus beyond publicly available target market determinations (TMDs) to hone in on issuers’ compliance with their reasonable steps obligations, including through the practical implementation of their DDO framework and processes.
- While an issuer’s TMD might meet all the statutory requirements, issuers may be vulnerable to enforcement action if they do not have adequate processes and procedures in place which make it reasonably likely investors who acquire their product are likely to be in the target market.
eToro’s TMD for the CFD product described the target market as ‘including’ clients who satisfied one or more of various categories, including those who—
- understand the risks and benefits of trading in CFDs
- invest only a proportion of their available funds in CFDs, and
- have prior trading experience.
The TMD said eToro’s assessment of appropriateness would be based on various screening tests. Understandably, the TMD did not include the precise content, criteria, or elements of the tests, or the scoring requirements for successful completion.
eToro’s screening test comprised a series of questionnaires purporting to assess whether a retail client fell within the target market for the CFD product.
ASIC alleges the screening test was of no real use as a distribution condition because it did little to exclude customers for whom CFDs were not appropriate. Put simply, ASIC alleged eToro did not effectively identify whether the investors were likely to be in the target market identified by the TMD.
The screening test was very difficult to fail as retail clients were permitted unlimited attempts to pass and were prompted to change their answers if they selected any which could cause them to fail.
Clients could only fail if they provided a particular combination of answers. Providing an ‘incorrect’ answer in isolation would not necessarily exclude or ‘knock out’ a client from the target market.
Moreover, if a retail client scored five or more out of a total possible score of 41, they were permitted to trade in the product.
The end result was clients who had no understanding of the risks of trading CFDs still fell within the target market.
Ultimately, almost 20,000 of eToro’s clients lost money through trading the CFD product.
Practical steps for product issuers
ASIC’s action against eToro is a reminder for product issuers to ensure their processes are fit-for-purpose. For example, if an issuer adopts distribution conditions which require an applicant to answer screening or filtering questions, then the issuer’s systems should ensure the data collected is analysed periodically to ensure retail investors who acquire the product are likely to be within the target market.
The case is a reminder ASIC remains active in the DDO space. It highlights ASIC has shifted its surveillance focus beyond publicly available TMDs to hone in on issuer’s compliance with their reasonable steps obligations, including through the practical implementation of their DDO framework and processes.
While an issuer’s TMD might meet all the statutory requirements, issuers may be vulnerable to enforcement action if they do not have adequate processes and procedures in place which make it reasonably likely investors who acquire their product are likely to be in the target market.
How we can help
We offer a full spectrum of DDO services, from advice on documents you prepare to a comprehensive in-house review of the implementation of DDO into the operations of your business.
Contact our Investment Funds team to find out more.
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