Implementing the DDO regime: hidden complexities to be aware of
We have discovered some surprising findings during our discussions with clients on the new design and distribution obligations (DDO) regime. Our series of articles will highlight some key issues you need to be aware of. In this article, we look at some of the hidden complexities in the new regime.
Complexities of the new DDO regime
A new way of manufacturing and distributing financial products will be required once the new DDO regime commences on 5 October 2021. The DDO regime is complex and raises a myriad of technical and tricky questions, and in our experience new questions arise all the time.
Even though the DDO legislation was designed to be principles-based, the detail of the legislation raises difficult questions.
What are we finding?
Here are some of the interesting things we are finding in our advice to clients:
- In considering product distribution, there could be surprising questions arising about whether issuers or distributors are authorised under their AFSL or authorised representative arrangements to engage in that conduct. That is, in considering whether an entity will be a distributor, that entity has been required to consider whether it will engage in ‘retail product distribution conduct’, which in turn requires an assessment of whether they might currently be giving general advice or arranging for a consumer to acquire a financial product. In doing this analysis, some entities may be surprised to find that their current AFS licence (or their authorisations as a representative of an AFS licensee) do not cover the financial services that are currently being provided, which then of course raises larger compliance issues than preparing for the DDO regime.
- Our clients have been asking about how the DDO legislation applies to distribution reinvestment, where the product will not otherwise be open to new investors. In our view, analysing ‘continuing products’ (ie existing products that continue to be issued to consumers after 5 October 2021) requires a careful reading of the DDO legislation, in particular where continuing products are issued where there is no need to give a Product Disclosure Statement (because of an exemption from the requirement to give a Product Disclosure Statement). We think that, under the DDO legislation and the existing product disclosure legislation, distinctions need to be drawn between making a target market determination (TMD), preparing a Product Disclosure Statement and giving a Product Disclosure Statement. Further, making a TMD (a design obligation) enlivens the distribution obligations for a continuing product because there is ‘retail product distribution conduct’ through the additional issues of the product.
- The residual distribution obligations of financial advisers who provide personal advice do not seem to be adequately addressed in ASIC Regulatory Guide 274 Product design and distribution obligations (RG 274) and, in our experience, do not appear to be at the forefront of the minds of dealer groups. This issue not only highlights the need for further communication and co-operation across different aspects of the financial services industry, but may also suggest a misunderstanding about those distribution obligations that still apply to advisers who provide personal advice. We will explore this further in a subsequent article.
- We understand from speaking with our clients that many product issuers do not have full visibility over the distribution of their products by financial advisers, in particular unaligned advisers with whom the issuers have no contractual or other relationship (because, being independent advisers, they may choose to recommend any product of their choosing and arrange for their clients to acquire the products). Upon discovering such ad hoc distribution channels, issuers may not wish to enter into formal contractual relationships with such advisers. ASIC’s guidance in RG 274 suggests that issuers may need to undertake some kind of vetting process (as well as, depending on the level of risk that may be associated with the adviser, formalising relationships) before ‘accepting’ them as a distributor. However, financial advisers providing personal advice enjoy the benefit of being carved out from some distribution obligations due to their activities falling within the definition of ‘excluded conduct’, and may also have no desire to enter into contracts with issuers.
- Whether there is a need to formalise distribution relationships into a distribution agreement between issuers and distributors is, in our experience, one of the key implementation questions facing the industry. Distribution obligations apply to distributors by operation of statute, regardless of the existence or non-existence of distribution agreements. However, as issuers are required to take reasonable steps so that distribution is consistent with the TMD and third party distributors are required to report to issuers, the communication between the parties will in any event at least form a pattern of agreed behaviour, which may in turn under law constitute an agreement by conduct.
What should you do?
To deal with some of these issues, we suggest that:
- issuers and distributors take legal advice on questions particular to their business;
- issuers consider undertaking a whole of business review of their current distribution channels and business activities to identify which third party entities are their distributors for the purposes of DDO;
- issuers and distributors review whether their AFSL authorisations are sufficient;
- take a risk-based approach to applying the DDO obligations to continuing products; and
- issuers and distributors examine the relative merits of entering into a new or amended distribution agreement.
Issuers and distributors should take steps to comply with the DDO regime, even if all of the intricacies of the regime are not immediately resolved or resolvable. We anticipate that, over time, new issues will arise not only before 5 October but also during the currency of regime.
The DDO regime represents a significant change to the regulation of financial products in Australia, and drafters of the DDO legislation could not have been expected to foresee all implementation issues or quirky questions that may arise in a complex and evolving industry. We also think that ASIC will take a ‘watch and learn’ approach in the short to medium term, and will further develop its guidance once there is lived experience with the new regime.
Please contact us if you have any questions about DDO.
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