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25.02.2020

News

ASIC guidance on the new design and distribution obligations

A review of ASIC's proposed guidance on how it plans to administer the new financial product design and distribution obligations (DDOs) reveals the devil may not be in the detail. Special Counsel Matt Moses explores the very high-level proposed guidance from the regulator and shares some practical takeaways for fund managers around governance processes, compliance frameworks, and distribution strategy.


Background

The DDOs were legislated back in April 2019, but do not come into effect until April 2021. Just before Christmas, ASIC released Consultation Paper 325 together with a draft regulatory guide seeking input from the industry by 11 March 2020. We earlier reported on the DDOs in the May 2019 edition of Fundamental.


Mainly high-level principles

The material released is lengthy—the Consultation Paper is 55 pages long, and the draft regulatory guide is almost 80 pages. Given the seismic shift to come about from the new regime in relation to how products are designed and sold and generally how fund managers and other issuers interact with consumers, there will be many eyes pouring over ASIC's words. They will be looking for some concrete sign-posts on how the regulator sees these new obligations working in practice, particularly given the quasi-financial advisory burdens some see as being imposed on issuers under the laws. However, the extremely broad nature of the obligations has (maybe unsurprisingly) led to very high-level proposed guidance from the regulator, with little in the way of any detailed practical rules a fund manager, for example, might follow.

In this regard, in the Consultation Paper, ASIC has said:

Our objective is for the guidance to be clear and useful, and to provide issuers and distributors with tools and direction to assist them to meet the design and distribution obligations. However, given the breadth and scalability of these obligations, which apply across the entire financial services sector, the draft regulatory guide is intentionally high-level, and principles-based.

This approach flows through ASIC's draft guidance. ASIC says it is up to product issuers and distributors to formulate their own approaches to implementing and complying with the new requirements. ASIC also recognises this is new territory for the Australian industry and the industry's approach. The regulator's approach is likely to develop and change over time, as everyone gets some experience under their belts (and presumably, as common approaches start to emerge across different product classes).

The high-level 'principles-based' approach is on the one hand positive, given that it will allow a fair bit of flexibility in how issuers and distributors go about interpreting and applying the design and target market obligations, especially in the remaining transition period. However, at the same time, some might think this regulatory approach does not help in delivering certainty around exactly what ASIC expects in relation to things such as what a target market determination for a particular type of product should look like. ASIC has said it does not propose to give definitive guidance on the content and form of any target market determinations, or on the formulation of a target market, because a 'one-size-fits-all approach' would not be appropriate. It seems it is up to the industry to develop approaches over time which hopefully become industry norms.


Considering consumer behaviour?

Given the principles-based approach ASIC is taking, there are some interesting points made by ASIC, some of which might lead to head scratching, especially in the absence of further clarification. One example is ASIC saying it considers issuers and distributors should not take advantage of 'behavioural biases' or factors that can impede consumer outcomes (eg the effect of behavioural bias on consumer interaction with information). Issuers and distributors should also consider 'consumer vulnerabilities' and how those vulnerabilities might increase the risk that products sold to consumers do not meet their needs and may lead to poor consumer outcomes.


Some more practical take-aways

Examples of some more practical points from ASIC's guidance include the following:

  • A key area ASIC does focus on is the role governance and compliance frameworks will play in the DDOs. ASIC uses the term 'product governance framework' and says issuers and distributors will need to develop and maintain effective product governance processes, across the life cycle of a financial product.
  • That means products need to be designed so they are consistent with the likely objectives, financial situation and needs of the target consumers, which ASIC thinks involves identifying the target market before designing the product and then 'testing the product', amongst other things.
  • We think that governance processes around the design of products and interaction with target markets is an area ASIC will focus on after the new obligations come into effect in just over a year's time. Fund managers and other product issuers should start to look at documenting a process and framework for the design of their financial products. First up, this covers identifying their target market and fitting the product features into that market, in a way which can be objectively understood and demonstrated.
  • Product issuers need to come up with a distribution strategy consistent with the identified target market and incorporate controls and restrictions on distribution. This is part of taking reasonable steps likely to result in distribution being consistent with the target market determination. An example given is a mortgage fund, where the fund manager becomes aware that a distributor is using language such as 'cash or cash-like' to promote the fund.
  • It is clear ASIC expects fund managers will actively keep tabs on their distribution network and how they are promoting the fund managers' products. This is going to present additional challenges for managers who do not just sell directly to their investors. There will be the need for documented procedures which are proactively implemented at all stages of the distribution cycle.

It will be interesting to see the industry's response and the approaches to the new obligations which will no doubt develop over the coming year and beyond.


Authors

Matt Moses

Matt Moses

Special Counsel

Contact McMahon Clarke

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