INSIGHT

Product design and distribution rules

By Michelle Levy
Banking & Finance Financial Services Insurance Private Capital Risk & Compliance Superannuation

In brief

Today Treasury released a paper seeking feedback on the proposed financial product design and distribution obligations, and proposed product intervention powers for ASIC. The proposals are intended to 'create new accountability obligations' for product issuers and distributors. On one view, it is a brave new world, on another, it is just more of the same. Which it turns out to be, we think, will depend on what product issuers make of it and what ASIC does with it. Industry has until March 2017 to make submissions on the detail, it is unlikely that more substantial objections to the policies will be successful. The Financial Services Regulation team report.

The paper

The paper contains proposed obligations for product issuers and product distributors. A product distributor is a new beast, who arranges for the issue or sale of financial products or who markets them. They do not include a person who provides personal advice. A distributor may or may not hold an Australian financial services licence.

The paper acknowledges that product innovation will be inhibited and that 'regulatory costs' will apply.  However, the measures should not result in 'unnecessary inhibition' or 'unnecessary costs'.

Product design obligations

The proposed product design obligations will apply to issuers of financial products to retail clients, whether or not they hold an AFSL.

Products covered

The obligations will apply to all financial products unless ASIC exercises an exemption power. The paper says that ordinary shares would be exempt because they are widely understood. We don't know whether there is research backing this observation and wonder whether it has more to do with the practical issue of imposing product design and distribution obligations on a company in relation to an issue of shares. That practical issue remains in relation to shares that are not ordinary shares.

The proposed obligations

In short, issuers will be required to design financial products that are useful (perhaps the obligation could extend beyond financial services), and to do this they will have to:

  • identify the target and 'non-target' market for their product by reference to the significant features of the product;
  • select distribution channels for the product – this is likely to require a level of due diligence by the issuer of the distributor and ongoing supervision and reporting that won't exist now. An interesting example will be whether an employer whose employees join the employer's default fund will be a distributor who needs to be supervised by the issuer; and
  • conduct post-sale reviews to determine whether the product is continuing to meet the needs of the target market. The post-sale review should consider customer feedback and complaints and profit margins. It doesn't say, but the implication is that some margins will be too high.

Issuers will need to consider the ability of consumers in the target market to understand the product. The paper notes that the complexity and risk of a product to consumers may necessitate testing of the target market prior to selecting a distribution channel. It also suggests that products with a broad target market would need to be tested. 

And it is this part of the proposal that reminds us a lot of the current obligation in the content requirements for PDSs for superannuation products and managed investment schemes to describe the 'type of investors for whom [an investment option] is intended to be suitable'. The kinds of descriptions that we see say things like: 'this option is suitable for an investor with a long term investment horizon and a high tolerance to risk'. We have resisted the temptation to speculate about what the target market for a complex structured product might look like and merely note that the proposals are not intended to unnecessarily dampen innovation.   

As to identifying the 'non-target market', we assume this means customers to whom the issuer has decided the product should not be issued. It is not clear what liability issuers will have to a customer in the non-target group of these consumers if, for example, a customer in this group ended up buying the product.

If a product issuer identifies that a distributor is selling a product outside the intended target market, it must raise this with the issuer and lodge a report with ASIC. The paper says that primary responsibility for distribution rests with the distributor but that a 'product issuer cannot be wilfully blind if distributors are acting inconsistently with expectations'.

Distribution obligations

The distribution obligations will apply to 'distributors', which is a term not currently used in the Corporations Act 2001 (Cth.). It will include those who arrange for the issue of products to a consumer or engage in conduct likely to influence a consumer to acquire a product in exchange for a benefit from the issuer.

The second limb of this definition will make it hard in many cases to work out whether someone is a distributor. Merely giving information about a product could make someone a distributor. The Life Insurance Remuneration Regulation will, when made, also extend the reach of financial services regulation to the provision of mere information in relation to insurance.

The obligations applying to distributors will  not be restricted to licensees and so many people who are not currently regulated will find themselves with new obligations under Chapter 7.

Distributors who provide personal advice will be excluded because they are already subject to what Treasury describes the more onerous duties under the FOFA provisions.

The proposed obligations on distributors will be to develop controls to ensure products are directed towards the target market identified by the issuer, and to comply with requests by the issuer for information appropriate to the issuer's review.

Again, ASIC will have the power to make exemptions.

The paper suggests that in some circumstances distribution through personal advice will be the only appropriate distribution channel for a product. Identifying the universe of products to which this might apply will be a tricky yet very important task. If this rule was applied to superannuation, in particular retirement income products, it would have the potential to undo a lot of the work currently being done by the Productivity Commission. 

Product intervention powers

ASIC will also be given broad product intervention powers under the proposal in relation to all financial products available to retail clients and consumer credit products. This is because of ASIC's supposedly limited ability to intervene outside a case of defective disclosure.

ASIC will be able to intervene in relation to the product, a product feature or the availability of the product to particular consumers. The paper provides examples of possible interventions, including additional disclosure obligations, requiring product warnings and restricting the availability of the product. The interventions could be market wide or specific to an individual product or issuer.

Before it could intervene, ASIC would be required to identify a risk of significant consumer detriment. It would be required to consult with affected parties and consider the use of alternative powers before utilising the product intervention power.

Any ASIC intervention would apply for up to 18 months, which is intended to give Government time to consider permanent intervention measures. Market wide interventions would be subject to parliamentary disallowance and individual interventions subject to administrative and judicial review.

Submissions

Treasury has allowed three months for consultation. Submissions close on 15 March 2017.