Design and distributions obligations: a review of ASIC’s final regulatory guide
In this article, we examine ASIC’s final regulatory guide on the design and distribution obligations (DDO) regime. In particular, we compare the final guidance with the draft regulatory guide released last year, and we identify some additional regulatory requirements with which ASIC expects compliance.
Key points
- ASIC’s final regulatory guide was released last week (11 December 2020).
- ASIC has refined its position on a number of matters since the draft regulatory guide was released 12 months ago.
- ASIC has also modified the operation of the DDO regime as it applies to exchange-traded products so as to deal with specific regulatory issues relating to such products.
- In our view, while much of the guidance is principles-based, we identify two areas of additional regulatory requirements imposed by ASIC that appear to extend beyond the express wording in the legislation.
Background
The DDO regime is implemented under the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 (Cth) (Act). The Act amends the Corporations Act 2001 (Cth) (Corporations Act) by inserting the DDO regime as a new Part 7.8A of the Corporations Act, subject to commencement of the regime on 5 October 2021.
On 11 December 2020, ASIC released the following suite of documents:
- ASIC Regulatory Guide 274 Product design and distribution obligations (RG 274). RG 274 is the final regulatory guide to which the participants in the retail funds management industry must refer in preparing for the DDO regime.
- ASIC Corporations (Design and Distribution Obligations-Exchange Traded Products) Instrument 2020/1090. This instrument set outs ASIC’s relief to the DDO regime to ensure that, in ASIC’s view, consistent obligations apply where exchange-traded products are traded on financial markets, and, among other things, issuers are not required to cease on-market distribution in circumstances where a TMD is no longer appropriate.
- Public submissions on ASIC’s draft guidance and the operation of DDO generally or in relation to specific aspects of the financial services industry.
- ASIC Report 674 Response to submissions on CP 325 Product design and distribution obligations (REP 674). REP 674 sets out ASIC’s thinking in response to the public submissions and how ASIC has dealt with them in RG 274 in relation to the points raised in the submissions.
The package of documents reflects a year-long consultation by ASIC. The draft regulatory guide was released in December 2019, and our article on that draft consultation package can be found here.
Due to the impact of COVID-19, the original commencement date of DDO of 5 April 2021 was deferred by ASIC for six months to 5 October 2021.
In addition, ASIC consulted with industry on the application of DDO to exchange-traded products (ETPs), given the unique position of market-makers in the product-issuing process for ETPs.
Comparing ASIC’s final guidance with its draft guidance
Set out below is a summary of the key points of difference between the draft regulatory guide released in December 2019 and RG 274. It shows ASIC’s developed thinking in relation to operation of the DDO under the Act.
| Matter | ASIC’s new guidance |
|---|---|
| New, continuing and legacy products | In respect of legacy products that are not affected by DDO, ASIC has clarified that products that are automatically reissued after initial acquisition (eg general insurance policy renewals or automatic rollovers of term deposits) involve the issue of a financial product. |
| Product governance arrangements | ASIC has replaced the term ‘product governance framework’ with ‘product governance arrangements’. According to ASIC, this is to be consistent with obligations under section 912A of the Corporations Act, which refer to ‘arrangements’ and ‘systems’ that are ‘adequate’. ASIC has strengthened its guidance on documenting product governance arrangements, stating that documentation is ‘required’ for issuers and distributors to demonstrate compliance (compared to stating in its draft guidance that documentation ‘helps’ issuers and distributors demonstrate compliance). |
| Consumer-centric approach | ASIC has highlighted the importance of a ‘consumer-centric’ approach, although the nature of ASIC’s guidance is not substantially different to its draft regulatory guide. ASIC has, however, provided further guidance on what it means to take a ‘consumer-centric approach’, including a non-exhaustive list on consumer vulnerabilities at RG 274.47. |
| Risk management approach | ASIC has introduced the concept of a ‘risk management approach’ to compliance with an issuer’s or distributor’s reasonable steps obligation, and to product governance arrangements in general. While there are references to reducing the risk of distribution outside the target market in the draft regulatory guide, ASIC has made this explicit in RG 274. |
| Making a TMD | ‘Appropriateness’ requirements ASIC has drawn a distinction between the following two types of requirements with which issuers must comply with respect to a target market determination (TMD): (a) ‘content requirements’, which go towards section 994B(5); and (b) ‘appropriateness requirements’, which go towards section 994B(8). ASIC has provided substantial further guidance in relation to the appropriateness requirements, including a new expectation that the TMD must ‘explain why the distribution conditions will make it likely that the consumers who acquire the product are in the target market’. See below for the ‘content requirements’ of the ‘appropriateness requirements’. |
| Key attributes ASIC has introduced the phrase ‘key attribute’ in RG 274. This concept refers to terms, features, and attributes of a product that affect whether it is likely to be consistent with the likely objectives, financial needs and consumers in the target market. A concept similar to key attributes is set out in the Revised Explanatory Memorandum to the bill in respect of the Act, being ‘key features’ that are relevant to determining the target market for a product. However, it was not made explicit in the guidance until RG 274. | |
| Target market ASIC has removed references to ‘inherently flawed’ products, agreeing in REP 674 with submissions that such products should not be offered at all. ASIC has provided more specific guidance on when a product may not necessarily be consistent with each of the likely objectives, financial position and needs of consumers in the target market, and has added examples of what factors may be useful in defining the target market, such as life stages or eligibility criteria in industry codes. Interestingly, ASIC has removed the term ‘negative target market’ in its guidance, but has retained its concept and use. ASIC has also added guidance in relation to the formulation of target markets for products that are intended to be held by consumers over an extended period of time. | |
| Requirements in relation to reviewing TMDs In RG 274, ASIC specifies that it expects the occurrence of a significant dealing to be specified as a review trigger in the TMD. ASIC has also added guidance that what is considered a ‘reasonable’ review period will likely be shorter where an issuer has limited experience issuing similar products or where they are yet to establish a ‘proven distribution network’. ASIC has added a new Example 14 in relation to when product changes may trigger the requirement to review a TMD (although this appears to be largely based on Example 1 in the draft regulatory guide in relation to credit card promotions). | |
| Complaints reporting ASIC has provided more specific guidance on what it considers to be an appropriate complaints reporting period, stating that a reporting period of a year or greater is ‘unlikely to be appropriate’ (compared to the draft regulatory guide, where ASIC suggested by way of an example that a five-year reporting period would be inappropriate). | |
| Information required to be reported by a distributor In RG 274, ASIC states specifically that it expects distributors to report not only the number of complaints but also the substance of complaints and general feedback about a product and its performance. In this respect, ASIC considers that this data is available as a result of current compliance ASIC Regulatory Guide 271 Internal dispute resolution. In its draft regulatory guide, ASIC suggested a list of that information that may be required from a distributor (eg conversion rates and web analytics). This list is removed from RG 274, but it appears that ASIC still expects issuers to obtain this information from other available sources (if not the distributor) as it is partially replicated in guidance on what information ASIC expects issuers to take into account when reviewing TMDs. | |
| Issuer’s reasonable steps obligation | Diversified portfolio ASIC has added guidance stating that managing the risk of a financial product being widely sold to consumers who do not have a diversified portfolio does not require issuers to have knowledge of each individual consumer’s financial situation. Rather, ASIC suggests that a ‘risk-based approach’ of the reasonable steps obligation is required, where exact nature of the steps an issuer should take will ultimately depend on the nature of the product and the circumstances of its distribution as well as available information. |
| Engagement with distributors In response to concerns from issuers that an issuer’s obligation to monitor and supervise distributors will be difficult to meet, ASIC states in REP 674 that issuers may be required to take steps to improve oversight or communication. In RG 274, ASIC further adds that in certain circumstances, a risk-based approach may mean that issuers need to stop distributing through certain channels. In relation to an issuer’s assessment of a distributor as part of the issuer’s reasonable steps obligation, ASIC has added an expectation that the assessment will include the distributor’s capacity to ‘meet its own obligations as a distributor’ (and not just capacity to meet the distribution conditions specified). This seems to call for a much broader assessment. | |
| Distributor’s reasonable steps obligation | In the draft regulatory guide, ASIC specified a table of factors that it expects will be relevant when considering whether a distributor has met its reasonable steps obligation. Importantly, in RG 274, ASIC now also specifies that it considers the factors in Table 6 to be a ‘starting point’ for distributors. In relation relying on existing information about a consumer, ASIC states that the use of existing information about a consumer for the purpose of checking whether a consumer is a target market would not constitute personal advice. |
| Significant dealings | ASIC has provided some additional factors it considers to be relevant in determining whether there is a significant dealing, and has clarified that issuers and distributors will likely differ on whether a dealing is ‘significant’. |
| Data collection | There are indications that ASIC expects issuers to undertake significant data collection and analysis in the process of creating and reviewing TMDs, including: - the insertion of an additional note under RG 274.100 indicating that the underlying data and analysis supporting the TMD is expected to form part of the issuer’s records; - ASIC’s guidance that ‘[d]ata and outcomes… should drive an issuer’s determination’ or whether a feature is a ‘key attribute’; and - the inclusion of an additional question at Table 3 (which sets out how an issuer should critically assess products) about what can be shown about ongoing benefits, risks and outcomes from data. In REP 674, in the context of data collection, ASIC has acknowledged that the DDO are a ‘step change’ and that compliance will ‘require changes to existing business practices and arrangements’. |
| Product-specific guidance | Exchange-traded products ASIC has included an appendix explaining how the DDO apply to issuers and distributors of ETPs, including modifications to the DDO regime implemented under ASIC Corporations (Design and Distribution Obligations—Exchange Traded Products) Instrument 2020/1090 (which was registered on 14 December). |
| Bundled products Where ASIC’s draft guidance required issuers to prepare separate TMDs for each product in a bundle, in RG 274 ASIC has permitted that issuers to either prepare separate TMDs for each product or prepare a single TMD in which content and appropriateness requirements are satisfied with respect to each product. In other words, there has been a change in form but not substance. Importantly, however, where a TMD is prepared for a bundled product ASIC requires issuers to also describe the target market and distribution conditions or restrictions for the bundled product (as opposed to its component products). | |
| Superannuation ASIC has inserted guidance on the interaction between DDO and APRA’s member outcomes framework in RG 274. Further, ASIC has today released a joint letter with APRA designed to assist RSE licensees to better understand the way in which the member outcomes obligations and the design and distribution obligations interact. In REP 674, ASIC states that it will not provide further guidance or modifications of the law on superannuation-specific issues including relation to reversionary pension interests, intra-fund transfers and superannuation splitting payments, noting its view that guidance in RG 274 on the reasonable steps obligation, including risk management principles, is sufficient. ASIC has also amended Example 9 in its draft regulatory guide (being Example 11 in RG 274) to remove suggestions that a superannuation trustee could customise the options presented in members on the fund website based on member characteristics information held by the trustee, and has replaced it with a suggestion that trustees may use filters to direct members away from unsuitable products. | |
| Consumer credit insurance ASIC has not included Example 4 of the draft regulatory guide (which was about consumer credit insurance in the context of product design and testing) in RG 274. | |
| IDPS and IDPS-like schemes ASIC has updated Example 8 in its draft regulatory guide about IDPSs (being Example 10 in RG 274) to include references to IPDS-like schemes. | |
| Listed investment companies ASIC has added a clarification to Example 11 in the draft regulatory guide (being Example 13 in RG 274) that the DDO apply to initial public offers and subsequent issuances of securities by listed investment companies (along with a note to the effect that the same principles apply for listed investment trusts). | |
| Other changes | ASIC has added guidance in relation to the implementation of personal advice by distributors who are not associated with the advice provider and in relation to referrers under the DDO regime. In RG 274, ASIC has also removed its guidance in the draft regulatory guide in relation to the ‘complementary’ interaction between the responsible lending obligations and DDO. |
Identifying ASIC’s new requirements
In our view, much of the guidance is principles-based and is consistent with the evident policy intent of the Act. The principles-based approach reflects ASIC’s position that industry will guide ASIC (not the other way round) about the implementation of the regime, at least during the initial phase of the implementation and operation of the regime.
It seems to us, however, that ASIC has some requirements about the operation of the DDO regime that are not expressly stated in the legislation. By this we do not mean ASIC’s guidance that explains concepts not defined in the legislation (such as ‘reasonable steps’ and ‘significant dealing’). Rather, we identify two areas of additional compliance that appear to extend beyond the express wording in the Act. This would suggest that RG 274 is not merely principles-based because ASIC requires additional requirements with which it expects compliance.
Appropriateness
In RG 274, ASIC has included guidance that it also expects the TMD to include:
- a description of the product, including its key attributes;
- an explanation of why the product is likely to be consistent with the likely objectives, financial situation and needs of consumers in the target market; and
- an explanation of why distribution conditions will make it likely that consumers who acquire the product are in the target market.
Section 994B(5) of the Act set out what is required to be included in a TMD, and does not refer to the three matters set out above. ASIC relies on the ‘appropriateness’ requirement in section 994B(8) to ground its expectations that issuers should include the above ‘appropriateness’ information in the TMD, However, ASIC’s guidance seems to blur the line between ‘content’ and ‘appropriateness’ requirements because these ‘appropriateness requirements’ appear to be mandatory content requirements of a TMD.
Complaints
Sections 994B(5)(g) and 994F(3)(a) and 994F(4) of the Act refer only to the number of complaints. However, in RG 274 ASIC states specifically that it expects distributors to report not only the number of complaints but also the substance of complaints and general feedback about a product and its performance. Interestingly, in RG 274.118 ASIC relies on section 994B(5)(h) (not section 994B(5)(g)) as the power by which an issuer can ask for this additional information, which suggests that an issuer may under this power specify in a TMD a wide range of information that it seeks from distributors, and under section 994F(5) the distributor must provide that specified information.
Preparing for the regime
The regime commences in 10 months. There’s a fair bit to do to implement the regime and there will be teething issues. We will have more commentary on the DDO regime in this preparation phase. We would be pleased to help you with this transition.
To help you prepare, we have created a DDO resource centre, outlining the practical steps you should take now to be prepared for when the DDO regime commences.