Implementing the DDO: making a target market determination

Continuing our series of articles about the new design and distribution obligations (DDO) regime, we look at the issue of making a target market determination (TMD).

The obligation to make a TMD

Generally, for a financial product that is within scope under the DDO regime, a person must make a TMD for the product if they are required to prepare a disclosure document (eg a prospectus) or a Product Disclosure Statement (PDS) for the product, issue or sell an ASIC Act product or are otherwise required to make a TMD under the DDO regulations. In general terms, the TMD-making obligation applies to financial product issuers.

What are we finding?

We are finding that a lot of energy has been spent settling a form of TMD. While a valid endeavour, we are only about three months away from the DDO regime commencement date (5 October 2021). Issuers and distributors alike must turn their attention to key questions around product governance, such as what it means to take ‘reasonable steps’ in distributing products in accordance with a TMD, identifying ‘significant dealings’ criteria and generally formulating a governance arrangements policy.

In preparing a TMD, we have found a number of issues come up, discussed below.

Scope of a TMD

Conceptual questions arise as to what constitutes a ‘financial product’ for the purposes of a single TMD. For example, a product may have different investment options or a managed investment product might consist of different classes of units. Some managed investment schemes (and investment portfolios within them) could also have different ‘layers’ of accessibility, such as those offering ‘managed discretionary portfolios’. Further, an investment option may be a notional allocation of investments to an investment strategy and, as such, may not constitute a separate ‘product’ for DDO purposes. The question arises as to which ‘level’ the TMD needs to be made.

PDS exemptions

Allied to the above point is the threshold question of whether a TMD needs to be made in the first place for a product. The primary TMD trigger is the requirement to prepare a PDS; however, there are a large number of exemptions from the need to prepare a PDS under the Corporations Act 2001, the Corporations Regulations 2001 or ASIC relief instruments. Engaging in retail product distribution conduct (such as issuing a product) does not of itself trigger the design obligation to make a TMD (setting aside issuing or selling ASIC Act products).

TMD standardisation

Various industry groups have prepared, or are in the process of preparing, template TMDs for a range of products. This effort will no doubt benefit those looking for consistency across the industry. We have found, however, that some clients have preferred to prepare their own template TMDs for various reasons, including because their products are non-standard or are bespoke, or because their products are relatively simple and therefore their TMD could be relatively simple.

Practicable distribution conditions and reporting requirements

There is an evident tension between, on the one hand, a product issuer’s obligation to prepare a TMD that ensures they comply with their regulatory obligations, including identifying a target market with specificity and identifying meaningful distribution conditions and reporting information, while, on the other hand, the product issuer’s interest in ensuring that information in the TMD and requirements regarding distribution conditions and reporting information could be implemented in practice by third party distributors.

Issuers could impose any number of distribution conditions and reporting information requirements with which third party distributors must comply (excluding financial advisers and ETP distributors to some extent) under force of law; however, imposing impracticable requirements in a TMD could cut off or reduce product sales. The regulatory risk is also heightened from the distributor’s perspective, as failure to comply with the ‘reasonable steps’ obligation and the reporting requirements are criminal offences and civil penalty provisions under the DDO regime.

Hypothetical vs actual investor

There is also a tension between the hypothetical class of persons comprising the target market and the actual customer that acquires the product. This tension is most evident in any attempt to define a target market or distribution conditions by reference to whether the consumer acquires the product as part of a diversified portfolio or otherwise in circumstances where the consumer does not receive personal advice before acquiring the product.

For example, if a TMD specifies that a product should only be acquired by persons whose holding of the product would comprise a specified percentage of their portfolio, issuers and distributors need to consider how they can apply this TMD condition in practice. If the issuer or distributor considers that compliance with this TMD condition requires knowledge of a particular investor’s own personal circumstances, financial situation and needs, how can this information be obtained where the issuer or distributor do not provide that investor with personal advice?

In this regard, it is useful to keep in mind that DDO does not prohibit a person outside the target market from acquiring the product (rather, the relevant test is whether the issuer and distributor have taken reasonable steps in managing the risk of the product being distributed to persons outside the target market). Further, ASIC reminds us (in RG 274.6) that DDO does not equate to an individualised product suitability test that requires assessment of each individual’s personal circumstances at point-of-sale. In addition, while it is helpful that the DDO regime excludes the act of asking for information solely to determine whether a person is in a target market from being considered to be personal financial product advice, drilling down into an investor’s portfolio holdings could exceed the boundaries of this exclusion.

Distributors’ capacity and needs

Drafting meaningful and practicable distribution conditions and reportable information requirements can be difficult. This is because distributors can be of various types (for example, platforms, dealer groups and third party websites) and each can have varying capacities to implement the distribution conditions (depending on their own level of resources and their IT capability).

There may also be significant diversity, needs and levels of sophistication within distributors of one type (eg financial advisers). Further, where a product issuer is also a distributor, it is not clear to what extent (if any) a TMD should set out distribution conditions for self-distributors, as such conditions would effectively bind the TMD-maker.

Level of detail in a TMD

The level of detail in TMDs can vary, particularly in relation to describing the product and its key features. There can be a temptation to describe the product’s features in a way analogous to a PDS; however, a TMD is not intended to be a disclosure document for consumers.

What should you do?

To deal with these issues, we suggest the following:

Delineate product offerings

In considering how many products could be described using the same TMD, it is helpful to note that ASIC acknowledges that a single TMD could be used for a product that has various permutations or ‘sub-markets’ (RG 274.125). However, an issuer still needs to consider the dividing line between forms of the same product on the one hand and, on the other, significant differential product features that constitute or warrant a new ‘financial product’ for the purposes of making a new TMD. A rule of thumb might be that each PDS warrants its own TMD, where issuers in practice identify a PDS with a single product.

Tailor TMDs

In preparing a template TMD, issuers should keep in mind that, in order to comply with their statutory design obligations, industry templates should be tailored to their own products and their own governance arrangements. The DDO legislation does not prescribe a particular TMD template, and neither does ASIC.

Write for your distributors

In preparing a TMD, product issuers should consider the audience for the TMD. The TMD audience is the distributor, not the retail client. Therefore, a TMD needs to be written with the distributor’s needs in mind as the distributor is the person that will need to interpret and apply the document. This is particularly important for two types of distributors, namely platform operators and financial advisers, as each of these types of distributors is likely to have special requirements regarding the ability to on-board and promote products. For example, a platform operator needs to accommodate numerous products on its platform and therefore will look for TMDs of underlying products to be as consistent as possible, particularly in relation to distribution conditions and reportable information. Financial advisers will look to see whether they can easily continue to advise on products on their APLs with as little disruption to their existing processes as possible (noting that the distribution obligations on financial advisers are significantly reduced relative to other types of third party distributors). However, as TMDs need to be publicly available, TMD makers need to be cognisant that retail investors may access and read TMDs as part of their investment decision-making processes, and therefore we also suggest that TMD makers write as clearly, concisely and effectively as possible.

Impose workable obligations

Product issuers should also keep in mind the implications of including unworkable distribution conditions and reportable information requirements in a TMD. This is because distributors are subject to statutory distribution obligations to take reasonable steps to ensure distribution is consistent with the TMD and to provide reportable information (with exceptions for financial advisers and ETP distributors), and issuers have statutory design and distribution obligations to review the TMD and halt distribution if the TMD is no longer appropriate. That is, distribution conditions and reportable information requirements should be able to be implemented effectively in practice.

Consider governance arrangements

For issuers that are self-distributors, it is worthwhile considering the extent to which distribution conditions should be specified in a TMD given that the conditions of self-distribution (and allied processes relating to the taking of reasonable steps) may be better set out in a product governance arrangements policy.

Engage with third party distributors

Given the DDO regime commences in about three months, issuers should quickly settle, populate and socialise their draft TMDs with their third party distributors in order to obtain feedback about them. TMDs can then be refined based on that feedback. The time it takes to get distributors ready to distribute products in accordance with the TMD should also be taken into account. Each TMD needs to be tested with distributors to ensure that the distribution conditions and reportable information requirements resonate with distributors and can be implemented in a practicable and effective manner. Keeping in mind that a TMD requires periodic reviews, as well as reviews where a review trigger occurs or other events or circumstances exist that warrant a review, issuers will have ample opportunity after the commencement of the DDO regime to refine their TMDs based on lived experience.

Please contact us if you have any questions about DDO.


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