Introduction: Consultation on draft DDO guidance

The Australian Securities and Investments Commission (ASIC) has released a consultation paper  — Consultation Paper 325 Design and Distribution Obligations (CP 325) — and draft guidance setting out its interpretation of new design and distribution obligations (set to commence on 5 April 2021); the regulator's expectations for meeting the obligations; and ASIC's general approach to administering them.

The deadline for submissions is 11 March 2020.  ASIC intends to release a finalised regulatory guide in 2020 (but no specific date is given).

An opportunity for industry to demonstrate a consumer-centric approach

Announcing the consultation, ASIC Deputy Chair Karen Chester said that the new requirements 'should drive better business and consumer outcomes. They simply require business to design products that meet genuine consumer needs and use distribution channels that will likely get them to the right consumers'.

Ms Chester added that the obligations also address the causes of much of the misconduct examined by the Royal Commission. 'Most of the Royal Commission case studies – from the mis selling of products to extremely poor value financial products – would have uniformly failed these obligations. The implementation of this  reform  presents a  significant opportunity for industry to demonstrate they have embedded a consumer-centric approach in their business and are better managing non-financial risks', Ms Chester said.

The AFR quotes Ms Chester as saying that the new obligations are also a 'cost-effective insurance policy for firms to deliver on that promise [to take care of their customers], and in doing so, stay off ASIC’s radar and reduce our obligation to enforce'.

Some key points

[Note: A summary of ASIC's proposals and questions on which ASIC seeks feedback, is included in CP 325 at p46] 

Principles based approach

ASIC says it has intentionally adopted a 'high level and principles based' approach with some examples to assist issuers and distributors in complying with their obligations while allowing a measure of flexibility.  ASIC says that it expects that its own approach, and that of industry will evolve over time.  'We expect that systems and processes will develop, be tested and be refined over time.  We expect to have a constructive relationship with industry during the implementation phase' ASIC states.

Customer centric approach

Proposed guidance on developing and maintaining a customer-centric product governance framework: ASIC proposes to issue guidance that a 'robust governance framework' (ie the systems, processes, procedures and other arrangements in place to help ensure compliance with design and distribution obligations in relation to product design, product distribution, information sharing between issuers and distributors, outcomes monitoring, and the conduct of reviews) should: a) focus on the identified target market across the lifecycle of the financial product; b) be designed to reduce the risk of products being sold to consumers that are inconsistent with their likely objectives, financial situation and needs; and c) fully documented, monitored, reportedly on and regularly reviewed for currency/effectiveness.

Expectation that issuers/distributors consider consumer vulnerabilities: ASIC also proposes to give guidance that issuers and distributors should not take advantage of behavioural biases or factors that can impede consumer outcomes.  In addition, ASIC expects issuers and distributors to consider consumer vulnerabilities and how these may increase the risk that products sold to consumers do not meet their needs and lead to poor consumer outcomes.

Proposed guidance for issuers

Target Market Determination

ASIC proposes to issue guidance proposing that what amounts to an 'appropriate target market determination can differ, depending on the type and particular characteristics of the financial product to be issued, the intended distribution approach and the issuer's product governance framework'.

• New products: ASIC proposes to issue guidance that, for new products, issuers should identify the target market and design financial products that are likely to be consistent with the likely objectives, financial situation and needs of consumers in that target market.
• Continuing products: ASIC proposes to issue guidance that, for continuing products, issuers should still critically assess the product (and its features) and identify the target market under the design and distribution obligations by reference to the likely objectives, financial situation and needs of consumers for whom the product would likely be consistent.  Where issuers already have processes directed towards these purposes, ASIC says that they should check that the processes meet the detailed requirements of the legislation.
• Content and form of a target market determination
  • No 'definitive formulation' (but examples given): ASIC does not propose to give any definitive formulation of how a target market should be described in a target market determination, but does propose to give guidance that explains the process and key considerations for identifying and describing the target market by reference to six examples across different product sectors.  Namely: credit cards, reverse mortgages, cash options in superannuation, consumer credit insurance, low value products and basic banking products.  With respect to consumer credit insurance (CCI), ASIC directs issuers to have regard to the problems identified in Report 622 Consumer Credit insurance: Poor value products and harmful sales practices (see: Governance News 17/07/2019) when they consider the design and distribution obligations for CCI products.
  • Obligation to specify certain information: ASIC proposes to give guidance on the issuer's obligation to specify in the target market determination: a) any information that it considers is necessary to require from its distributors in order to promptly decide that a target market determination may no longer be appropriate; and b) the reporting period for the information the distributor must provide to the issuer about the number of complaints about the financial product.
• Diversification: ASIC proposes to give guidance that when an issuer considers it appropriate to contemplate consumers in the target market acquiring the financial product as part of a diversified portfolio, the reasonable steps obligation will require the issuer to manage the risk of the product being sold to consumers who do not have a diversified portfolio.
• Should not be based 'predominantly' on consumer understanding: ASIC proposes to give guidance that it does not consider a target market for a product should be predominantly based on consumer understanding of a product as it considers that consumer understanding of a product does not necessarily equate to the product being likely to be consistent with the likely objectives, financial situation and needs of consumers in the target market.
• Who is the product clearly unsuitable for? (consideration of the 'negative target market'): ASIC proposes to provide guidance that in making a target market determination, it will also be useful for the issuer to consider, in addition to the target market, those for whom the financial product is clearly unsuitable (the negative target market).
• Guidance on the application of the target market determination to specific products: ASIC proposes to give guidance on how the target market determination applies for certain products when the application of the obligation is 'not straightforward', including on the application of DDO to: a) superannuation and investor directed portfolio services (also known as 'platforms' or 'IDPS'); b) when products are offered and acquired as a 'package' or 'bundle'; and c) when products are customisable by the consumer at point-of-sale, including through choices or options (eg selecting a waiting period for an income protection insurance product).
• Issuers' obligation to take 'reasonable steps': An issuer has a legal obligation to take reasonable steps that 'will or are reasonably likely to result in distribution being consistent with the target market determination' for the financial product.  Consistent with the principles-based approach to guidance on the DDOs generally, ASIC's proposed guidance is 'high level' and 'principles based' on the basis that it considers 'an issuer is best placed, given its knowledge and experience of its financial products and distribution channels' to consider the appropriate approach. To assist issuers, ASIC's proposed guidance lists the factors it will consider in its administration of the reasonable steps obligation including: a) the distribution conditions that are specified in the target market determination; b) the issuer's marketing and promotional materials; c) the selection of distributors; d) the supervision and monitoring of distributors; e) the issuer's ability to eliminate or appropriately manage conflicts of interest; and f) whether issuers have provided distributors with sufficient information to help them ensure that distribution is consistent with the target market determination.
• Reviewing the target market determination: Issuers have a legal obligation to review the target market determination periodically and in response to review triggers to ensure that it remains appropriate for the product over time.  However,  how frequently an issuer should review the target market determination and what circumstances should trigger a review are not specified in order, ASIC says, to enable issuers to determine the most appropriate and effective review process for its particular financial product and existing systems/processes.  Accordingly, ASIC's proposed guidance does not identify standard review triggers and maximum review periods for issuers to adopt.  Rather, the draft guidance sets out examples to illustrate what review triggers may be appropriate for certain types of financial products (insurance, managed fund).   ASIC proposes to give guidance that, in reviewing a target market determination, it expects the issuer to take into account all available information on its financial product, using multiple data sources.
• Factors issuers should consider when determining if there has been a 'significant dealing'? An issuer must notify ASIC of a significant dealing (except excluded dealings) in a financial product that is not consistent with the product's target market determination.  An issuer must determine whether or not a dealing is 'significant' based on the circumstances of each case.  ASIC proposes to provide guidance that relevant factors may include: a) the proportion of consumers who are not in the target market acquiring the financial product; b) the actual or potential harm to consumers; and c) the nature and extent of the inconsistency of distribution with the target market determination.

Proposed guidance for distributors

• Factors relevant to considering whether a distributor has met the reasonable steps obligation: ASIC proposes to give high-level guidance on the reasonable steps obligation for distributors of financial products by setting out its view on factors that may be relevant to this obligation, including: a) the distribution method(s) used; b) compliance with distribution conditions; c) the marketing and promotional materials circulated by the distributor; d) the effectiveness of the distributor's product governance framework; e) the steps taken to eliminate or appropriately manage the risk that incentives for staff or contractors may influence behaviours that could result in distribution being inconsistent with the target market determination; f) whether reliance on existing information about the consumer is appropriate; g) whether the distributor has given staff involved in distribution operations sufficient training; and h) how the distributor forms a reasonable view that a consumer is reasonably likely to be in the target market.
• General insurance renewals: ASIC observes that the reasonable steps obligation will apply at the point of renewal and therefore, some consideration of whether the consumer remains in the target market at each renewal may be required.  ASIC's proposed guidance outlines how insurers (in their role as distributor) can approach the reasonable steps obligation in the context of renewal of general insurance policies, to ensure that the renewal process results in outcomes that are consistent with the target market determination.  ASIC proposes that, at the time of renewal, an insurer should: a) analyse information it holds (eg information it gathered when the customer initially acquired the product; b) note any updated details that have been provided and/or have been provided through claims that have subsequently occurred; and c) consider a number of factors, including the likelihood that a class of consumers is no longer in the target market for the policy.  ASIC states that where an insurer assesses that it is likely that a consumer is no longer in the target market for an insurance policy, this should not result in an insurer declining to offer a renewal of the policy without contacting the consumer.
• Is a consumer reasonably likely to be in the target market?

Financial advisers

ASIC expects distributors to have 'effective systems and processes in place to enable it to form a reasonable view on whether a consumer is reasonably likely to be in the target market for a product'.  In most cases, ASIC considers that a distributor should have sufficient information about a consumer through its existing sales processes to form a reasonable view on whether the consumer is reasonably likely to be in the target market for a financial product.  The proposed guidance suggests a number of ways which could assist distributors in forming a reasonable view including: a) the inclusion of 'knockout questions' within application processes; b) analysis of data held on the consumer or a class of consumers; and c) in some cases, asking the consumer direct questions to determine whether they are reasonably likely to be in the target market.

In addition, the proposed guidance proposes to outline the steps that a distributor can take to reduce the likelihood that a consumer will be left with the impression that their personal circumstances have been considered, including: a) not having a relevant provider (an individual authorised to give personal advice to consumers on relevant financial products) involved in the distribution process to ask specific questions of a consumer and communicate the view that the consumer is in the target market to the consumer; and b) only asking specific questions of a consumer (when required) in the later stages of the sales process after the consumer has already made the decision to acquire the financial product.

• Consumers outside the target market: A distributor must comply with the reasonable steps obligation in the event that it becomes aware that it is interacting with a consumer who is outside the target market for a financial product. ASIC's proposed guidance seeks to 'provide some clarity in relation to the way in which distributors should approach these situations'.  More particularly, ASIC proposes to provide guidance that the reasonable steps a distributor should take when selling a financial product to consumers who are outside the target market for the product depends on the circumstances of the interaction, the nature and degree of harm that might result, and the steps that can be taken to mitigate the harm.
• Provision of information to issuers: A distributor must report certain information on its distribution to the issuer.  ASIC does not propose to provide specific guidance on the practical aspects of the relationship between the issuer and the distributor regarding information exchange on the basis that these are 'commercial matters that issuers and distributors can determine among themselves'. However, ASIC states that it will consider, following feedback, providing 'guidance on specific aspects of the relationship to promote consumer or competition outcomes'.
• Applications for relief — guidance on relevant factors: ASIC proposes to give guidance on the factors that it will take into account when considering whether to provide an exemption from/modification to the design and distribution obligations.  These factors include: a) whether the objects of Ch 7 of the Corporations Act 2001 (Cth) are being promoted, including the provision of suitable financial products to consumers (see s760A(aa)); b) the policy intention underlying the design and distribution obligations to both improve consumer outcomes and require financial services providers to have a consumer-centric approach to making initial offerings of products to consumers; and c) parliament's intent (as reflected in the law) for these obligations to apply to a broad range of financial products.
• Interaction with disclosure relief: ASIC proposes to give guidance that, if it grants disclosure relief for a financial product, relief from the design and distribution obligations will not automatically follow.  If requested, ASIC will consider whether to grant relief from the design and distribution obligations as a separate matter to its consideration of disclosure relief.  ASIC explains that the proposed approach reflects the separate underlying policy rationales of the disclosure regime and the design and distribution obligations.