Design and Distribution Obligations commence on 5 October 2021
In December 2019, ASIC issued a draft Regulatory Guide and consultation paper on the Design and Distribution Obligations (DDO). After a long delay, it has issued the final Regulatory Guide 274 (the RG).
Not much of the draft was untouched, and there is a lot of new content on which there has been no consultation. Significant parts of the content purport to impose obligations that are not imposed by the Corporations Act. The point is well made by comparing the Act's handful of pages containing the DDO with the 91 pages of the Regulatory Guide.
We set out in this update an overview of how the final RG deals with a number of key questions raised by issuers and distributors. We first look at issues relevant to all industries, and then some particular questions for banking, superannuation and investments, and insurance.
Key Q&A's on Design and Distribution Obligations:
The final RG notes that an issuer needs to consider the design of its products, including each product's 'key attributes', and to determine an appropriate target market for the product. The term 'key attributes' was not used in the draft RG. ASIC uses the term in the final RG 'to describe features and attributes of a product that affect whether it is likely to be consistent with the likely objectives, financial situation and needs of consumers in the target market'. This ties back to the assessment of whether the TMD is appropriate under section 994B(8).
Under the DDO, the term 'target market' has its 'ordinary meaning'. The final RG does not deal with the meaning of 'target market' and ASIC does not explain what it thinks it means. It uses the phrase 'the class of consumers for whom the product is intended', which is the closest it gets to defining the term.
The final RG says that 'The class or classes of consumers that comprise the target market for a product should be defined by an issuer with objective, tangible parameters so that it is clear which consumers form part of the target market'.
It is unclear what ASIC has in mind by 'objective, tangible parameters'. It says issuers may be assisted by eligibility criteria set out in industry codes for certain types of products (such as low- or no-fee transaction accounts dealt with in the Banking Code of Practice). Presumably, the eligibility criteria imposed by issuers are examples of 'objective, tangible parameters' ASIC has in mind. But the target market for a product will rarely be limited to those who meet the eligibility criteria. What additional 'objective, tangible parameters' issuers should impose are unclear, although the suggestion is that they may be lengthy.
The final RG includes similar guidance in relation to how the distribution conditions set out in the TMD should be described, noting that they 'should be specified in the TMD with tangible parameters so that these conditions are objectively clear (e.g. restricted to branch sales or through a dedicated customer contact centre)'.
ASIC has dropped any reference to a 'negative target market'. We think this is an improvement to the draft RG because the concept is not referred to anywhere in the legislation and the discussion in the draft RG caused confusion – including questions about whether ASIC expects TMDs for certain products to always include a negative target market.
While it has removed references to 'negative target market', the RG retains the concept. The RG notes that 'specifying classes of consumers that are excluded from the target market could be useful in setting the distribution conditions and restrictions for the product'. It provides examples of groups of consumers who may need to be excluded – such as those who are unable to claim under an insurance product, and those consumers with a low risk tolerance who may need to be excluded from a high-risk product.
While it may in some cases be necessary to exclude groups of consumers, it seems to us that the examples provided could be addressed through appropriately formulating the target market for the products and through the issuer's and distributor's reasonable steps obligations. It may not be necessary (or appropriate) to specifically exclude groups of consumers through the distribution conditions and restrictions.
The content of a TMD is prescribed by s994B(5). However, the legislation is not clear on how much detail issuers should include in the TMD. It seems that ASIC wants issuers to err on the side of including more detail rather than less. This could unnecessarily replicate information provided elsewhere (such as the disclosure document or terms and conditions of the product). It also makes it more difficult for issuers and distributors to know what reasonable steps are required given distribution should be 'consistent' with the TMD.
The final RG includes some puzzling new guidance about additional information that ASIC thinks should be included in the TMD. It says:
To meet the appropriateness requirement in s994B(8)(b), an issuer generally will need to set out in the TMD:
- a description of the likely objectives, financial situation and needs of consumers in the target market;
- a description of the product, including its key attributes; and
- an explanation of why the product, including its key attributes, is likely to be consistent with the likely objectives, financial situation and needs of consumers in the target market. This will require the issuer to have critically assessed and tested its product.
This is not required by the DDO. Section 994B(8)(b) is a test or standard to be applied in assessing the content of the TMD. An issuer has to form the view that the TMD is appropriate having regard to the requirements in s994B. While it will be helpful for issuers to consider the above information in formulating a TMD for a product, the section does not require the additional content be included in the TMD. An issuer can be satisfied that the TMD is appropriate for a product without setting out the above information in the TMD.
Similarly, the final RG says that:
- To ensure that distribution of the product is directed towards consumers in the target market, the issuer must specify the following in its TMD:
- appropriate conditions and restrictions on distribution of the financial product (distribution conditions); and
- why these distribution conditions and restrictions will make it more likely that the consumers who acquire the product are in the target market.
While the distribution conditions are required to be specified by s994B(5)(c), there is no requirement under the DDO to include an explanation in the TMD of why the distribution conditions will make it more likely that consumers will be in the target market. ASIC says that '[a]n issuer is unlikely to be able to reasonably conclude that its distribution conditions will make this outcome likely without meaningful consideration of how its distribution conditions affect which consumers the product will reach'. This may be true. But it does not follow that the TMD must set out the issuer's reasoning. The issuer can consider these matters and specify the distribution conditions in the TMD without also setting out all of its considerations and reasoning.
The final RG says that '[a]n issuer needs to ensure that the objectives and financial situation and needs of a class of consumers are consistent with the product'. This comment is made in the context of an example of a credit card product where ASIC notes that a high-interest-rate card may be consistent with a customer's objectives, but not with their needs of financial situation.
This raises questions about how issuers and distributors should deal with consumers who want a product (and so in that sense meet the consumer's 'objective'), but the product in other respects may not be appropriate for a consumer's circumstances. Consumers objectives, financial situation and needs may themselves be inconsistent – consumers may want products that will involve incurring higher fees or more interest. Issuers and distributors will need think about what they do about these consumers, and whether they need to be excluded from the product or whether they can acquire it. A reasonable step in these circumstances may be to make clear to consumers that the product is not intended for those with particular financial situations or needs.
The final RG says that ASIC 'would expect an issuer’s TMD to include a review trigger relating to the occurrence of a significant dealing'. This was not included in the draft RG and is not required by the DDO provisions.
While in many cases an issuer may want to review the TMD in the event of a significant dealing that is reported to ASIC, issuers may receive many reports of significant dealings by distributors that will not be significant dealings when considered in the context of their overall business. And even those significant dealings that are reported to ASIC may be the result of issues that have nothing to do with the TMD. Imposing this as a blanket requirement in all TMDs may require issuers to review TMDs much more frequently than is necessary or sensible.
ASIC says that bundled products can be covered by the same TMD. The term 'bundled' is not defined, and the references to 'financial product' and 'product' in the RG do not reflect the treatment in the Corporations Act. A financial product in the Corporations Act, including the DDO, refers to each financial product issued to or held by a consumer – it is each insurance contract issued to a policyholder, each interest in the superannuation fund or managed investment scheme and each credit contract issued to a borrower.
Despite this, ASIC uses the term to refer to the group of products issued under common terms or branding, and bundled products appears to refer to cases where a product issuer offers a financial product together with another financial product – either under the same terms and conditions (in which case they may be one or more product depending on the terms), or products that are required to be acquired and held at the same time (such as, perhaps, a savings account that can only be acquired if a transaction account is also held with the same issuer).
The final RG says:
When an issuer sells multiple products together as a bundle, the issuer can decide whether they will comply with the TMD content and appropriateness requirements for each product in the bundle in a single TMD or, alternatively, prepare separate TMDs for each product within the bundle.
However, the target market for each product, as well as the distribution restrictions and appropriateness test for each product, will need to be considered separately, as well as for the bundled products together. ASIC expects that the target market for the bundled products to be narrower (a sub-set) of the target markets for each individual product.
The RG does not address how a bundled product should be dealt with where one of the products is covered by the DDO but another is not. A TMD is clearly not required for products not covered by the DDO. It seems to us likely that an issuer would need to take into account the other products required to be acquired by the consumer as a conduction of acquiring the DDO-covered product in formulating the TMD for the DDO product.
ASIC has retained the guidance from the draft TMD about how a TMD should treat options or choices that a consumer may be able to make about a product. It says in the final RG that:
When there are different target markets for differing forms of the product (as a result of particular options or choices), this must be addressed in the TMD for the product. For example, an issuer could describe the target market for the relevant choice or describe the target market for different permutations of the product, including, for example, sub-markets where appropriate. An issuer does not need to prepare a separate TMD document for each choice or permutation of the product.
While this is easy enough to deal with where the choices or options are few, and so there are a small number of permutations of the product, it is more difficult to deal with when there are many options or choices that could be made.
ASIC says that if a product promotion is concessional (such as a reduction in the fee charged), it is likely that the existing target market will remain appropriate. But if the promotional feature will encourage people outside the target market to acquire the product and the distribution conditions are unlikely to limit distribution to those within the target market, the issuer may need to review the TDM and adjust the target market and distribution conditions.
We think that rather than having to adjust the TMD and distribution conditions, it would usually be more appropriate for the issuer and distributor to review how they will comply with their reasonable steps obligations. A promotion may require clear disclosure about who the product is intended for and which consumers the promotion is likely to benefit. It may not require changes to distribution conditions specified in the TMD. And a requirement that issuers review a TMD every time a promotion is offered would impose an onerous obligation that has potentially serious consequences for an issuer if not complied with.
The final RG makes clear that the DDO are not 'an individualised product suitability test that requires assessment of each individual’s personal circumstances at point-of-sale'. The obligations on issuers and distributors are directed to ensuring the product is likely to be appropriate for the client to whom it is issued, which directs attention more to the arrangements in place for product issuance and distribution, rather than how the process worked for an individual client.
ASIC notes that distributors may decide to ask consumers specific questions in order to determine if they are within the target market for the product, and that this may be exempt from being personal advice if it is for the sole purpose of determining whether a consumer is within the target market. However, it also notes that if the questions are also intended to influence a consumer in making a decision about the product, this may not be covered by the exemption and may involve personal advice. This provides little comfort, as in many cases it may be difficult to determine whether questions asked for the purposes of complying with the reasonable steps obligation could also influence consumers in making decisions.
ASIC has retained its guidance that distributors could reduce the risk of influencing consumer decisions by ensuring those involved in asking questions are not authorised to give personal advice, and by waiting to ask questions 'in the later stages of the sales process after the consumer has already made the decision to acquire the product.' Both suggestions are unsatisfactory. Consumers will not necessarily know or understand the restrictions on employees providing personal advice, and it is unlikely to have any impact on their perception of whether their circumstances are being taken into account. And leaving key questions about whether the consumer is in the target market for a product may also result in consumers going a long way down the path of wanting to acquire a particular product only to discover that it is not appropriate for them. We think that issuers and distributors should be able to take steps to confirm if a consumer is in the target market as quickly as possible.
ASIC also says that:
if a distributor relying on the exemption informs a consumer that they are in the target market for a financial product, the distributor must not suggest or imply that it has considered the consumer’s personal objectives, financial situation and needs or that the product is suitable for the consumer’s individual circumstances. To do so may be misleading or deceptive and would fall outside of the exemption.
However, if a distributor has asked specific questions of the consumer about their circumstances as part of the reasonable steps, it is difficult to avoid the implication that it has considered these circumstances. And in subsequently communicating to the consumer that they are within the target market, it is also difficult to avoid the implication that the product is suitable to the consumer's individual circumstances.
Another issue, which ASIC does not address in the RG, is that the exemption for dealing in order to implement personal advice given to a consumer covers only 'arranging for a retail client to apply for or acquire the product'. It does not cover issuing the product. So while a distributor may be able to rely on the exemption, an issuer will still need to take reasonable steps in the circumstances. However, the details of the reasonable steps required in the circumstances can take into account the fact that the consumer is being given personal advice.
The RG says that, in assessing whether issuers have complied with their reasonable steps obligations, ASIC will consider whether the issuer has adequately supervised and monitored the distribution of its product. It is unclear what ASIC expects issuers to do in this regard.
The DDO provisions do not specifically require issuers to directly supervise and monitor distributors. They need to specify distribution conditions, and reporting required to be received from distributors. They also need to take reasonable steps – and these could involve strengthening the ability to oversee and monitor distributors. But in many cases an issuer will have limited or no relationship with distributors, and its ability to monitor and supervise their conduct will be practically constrained.
Issuers will need to specify in the TMD the information distributors are required to report on a regulator basis. The final RG says:
In setting the information requirements under s994B(5)(h) we expect that issuers will find it necessary to require that distributors provide not only the number, but also the substance of complaints and general feedback relating to the product and its performance.
The final RG says:
Existing information about a consumer or class of consumers held by a distributor could, as part of meeting its reasonable steps obligation, be used to determine whether the consumer is reasonably likely to be within the class of consumers for which the product is likely to be appropriate. Using existing information in this way for the purpose of checking whether a consumer is in the target market would not constitute personal advice.
While using existing information may be helpful to an issuer or distributor as part of taking reasonable steps, the exemption for personal advice covers only 'asking for information solely to determine whether a person is in a target market'. It does not deal with use of existing information about a consumer's circumstances.
ASIC provides an example:
For example, if the target market for a product includes only employed people, and the distributor’s records indicate that the consumer is unemployed, the distributor would not be complying with its reasonable steps obligations if it sold the product to the consumer.
This would not necessarily be the case. If the distributor has reason to believe that the consumer is now employed, it would not necessarily fail to comply with its reasonable steps obligations by issuing the product to the consumer even if it held information about the consumer that indicated that the consumer is unemployed. This would depend on the age and source of the information. It may be reasonable for an issuer or distributor to rely on more up-to-date information provided by a consumer rather than relying on existing information.
ASIC provides limited additional guidance about what a 'significant dealing' is (for the purposes of the obligation to report significant dealings that are not consistent with a product's TMD). However, it has added the following comment:
Issuers, who have an aggregate view of the distribution of their product, will take a more systemic approach to determining whether a dealing is significant.
It is unclear exactly what ASIC means by this comment. It could mean that ASIC expects that issuers will (or should) have a system in place for determining whether a dealing is significant. More likely ASIC is suggesting that issuers would assess whether a dealing is significant having regard to the distribution of the product in 'aggregate' and possibly whether the dealing outside the target market is 'systemic'. This suggests that issuers may not need to treat a dealing as significant if it is isolated and not significant having regard to the overall issuance of the product. It also notes that whether a dealing is significant will likely differ between distributors and issuers, given the differences between their businesses.
ASIC encourages issuers, in determining whether a particular dealing is significant, to 'set objective criteria based on the nature and risk profile of their product' and that are 'widely available'. ASIC does not give examples of what such criteria might be.
Under the DDO, promotional material for a product that has a PDS must describe the target market or where the TMD may be accessed. For other products, no reference to the TMD or target market is required.
ASIC thinks that broad advertising of products with a narrow target market may not be appropriate. It says that the 'disclosure necessary in these circumstances is more than the minimum disclosure about the target market required in promotional material by the obligations'. This suggests that advertising of products with narrow target markets may be appropriate, but additional disclosure may need to be included to make clear that the product is directed to a narrow group.
Responsible lending has been scrubbed from the final RG. There is no reference to how the DDO will interact with the responsible lending obligations that will remain even after the proposed changes to remove the obligations from most consumer lending. There is also no reference to the proposed extension of the best interests duties to all credit assistance providers.
Issuers and distributors will need to comply with each of their obligations and will need to assess the steps they put in place to ensure they are adequate for these purposes. It may be possible to use some existing processes (such as existing responsible lending enquiries) for the purposes of satisfying the reasonable steps obligations. Any changes to these processes will need to be assessed having regard to each of the obligations that need to be complied with.
The final RG notes that the terms 'dealing' and 'financial product advice' (as used in the term 'retail product distribution conduct' in the DDO provisions) 'also apply to financial products that are not regulated by the Corporations Act, but are regulated under the ASIC Act', such as credit facilities. The example given is that 'arranging for a consumer to apply for a home loan would constitute retail product distribution conduct'.
For the same reason, the term 'personal advice' as used in the term 'excluded conduct' can also be given in relation to ASIC Act products. The final RG notes that this means 'excluded conduct currently covers conduct in the nature of personal advice that is provided in relation to products that are regulated under the ASIC Act, as well as those regulated under the Corporations Act'.
The final RG notes that credit provided for business purposes is exempt from the DDO under the DDO regulations. But it does not address in any detail what is required for a lender to be satisfied that lending is for business purposes, or how the exemption from the DDO interacts with the existing business lending exemption under the consumer credit regime.
The RG says that '[w]hile the member outcomes framework and the design and distribution obligations are distinct regimes, they are complementary. Efficiencies may arise in developing compliance arrangements for each of the regimes'.
ASIC said in the response to submissions that it will be releasing a joint communication with APRA on the subject shortly.
The DDO clearly do not require the TMD for a superannuation or investment product to set out the target market for each investment option offered within the product.
The draft RG suggested that ASIC is expecting a TMD for a superannuation or wealth product to include the target market for each individual investment option. The final RG notes that investment options are likely to be 'key attributes' of the product, and that:
[t]he trustee should take this into account in preparing the TMD for the choice product. In practice, this is likely to involve a single TMD for the choice product that describes multiple sub-markets for investment options or groups of investment options offered as part of the product.
This suggests that a TMD for a superannuation or investment product that offers multiple investment options would need to describe the 'sub-markets' for each investment option. The industry has previously pointed out that this is likely to be unworkable and highly complex. The target market for an investment product is likely to be the class of consumers who want to be able to make investment choices and want access to the range of products offered. Many products also regularly change investment options on offer. We think that describing the sub-markets for individual products is likely to be impractical in most cases.
ASIC notes in the final RG that, if an issuer of an investment product chooses to target consumers who are likely to hold the product as part of a diversified portfolio, it will need to 'comply with its reasonable steps obligation by managing the risk of the financial product being widely sold to investors who do not have a diversified portfolio'.
ASIC does not provide any additional guidance about the circumstances in which an issuer should restrict the target market to those who are likely to hold the product as part of a diversified portfolio, or more concretely, what reasonable steps should be taken.
DDO requires TMDs to be made for the initial issue of certain exchange traded products. However, there was previously some complexity as to the distinction between an initial issue being conducted through an external market maker (EMM) structure, where the initial issue is to an authorised market participant prior to sale to retail clients on a financial market, as compared with an internal market maker (IMM) structure, where a trading participant facilitates the issue of products on the market as the issuer's agent. ASIC has made an instrument (ASIC Corporations (Design and Distribution Obligations—Exchange Traded Products) Instrument 2020/1090) (the ETP Instrument) that amends the Corporations Act and Corporations Regulations to clarify that an issuer of an ETP is required to make a TMD for an ETP that is designed to be sold to retail clients, regardless of whether an EMM or IMM structure is used.
In addition, there was ambiguity in the draft RG whether DDO applies to the secondary sale of those products. ASIC listened to the feedback and, through the ETP Instrument, has modified the way the DDO apply to ETPs. The modifications mean that, while an issuer of ETPs must review its TMD as necessary, it is not required to cease on-market distribution in circumstances where a TMD is no longer appropriate as practically they are not in a position to stop the trading in the product on a financial market. And distributors of ETPs will only be required to comply with the obligation to keep records of complaint information and information that an issuer specifies in the TMD.
ASIC also acknowledges in the final RG that, in complying with its reasonable steps obligations, the steps able to be taken by the issuer of an ETP may be limited to the way it markets the product and interacts with consumers, given brokers providing execution-only services will not be able to modify their services in order to limit distribution.
In ASIC's view, yes. The final RG says:
In considering whether the insurance component changes the class of consumers for whom the superannuation product (including its key attributes) is likely to be appropriate, trustees could have regard to members for whom insurance is unlikely to be appropriate. For example, the trustee should consider whether occupational or other factors would result in the members being ineligible to claim under the cover.
ASIC seems to suggest that insurers need to take additional care when renewing policies, to ensure that consumers remain in the target market. They may need to consider information held about the consumer and any updates received. The reasonable steps that may be required may depend on the number of renewals already been completed. For example, additional 'controls' may be required 'after the fourth or fifth renewal following initial policy purchase' if the risk of consumers no longer being in the target market increases significantly.
We query whether insurance distributors would be required to take significant additional steps in most cases for most renewals of policies. Unless the policy terms have changed or there is information that would suggest the consumer is no longer in the target market (such as reaching an age at which they cease to be eligible for certain benefits), it may be sufficient to provide consumers with information about any changes, and reasonable to assume that these consumers remain in the target market.