Get ready for the new design and distribution obligation regime
New financial products' legislation puts the customer at the centre of design and distribution considerations, but the obligations fall on issuers and distributors.
October 5 marks the beginning of what might be seen as the final phase of the reforms from the Hayne Royal Commission with a raft of new laws being introduced, including the Design and Distribution Obligations (DDO) for financial products. Conceived to ensure products are created and distributed with the customer’s requirements in mind – rather than the interests of the company that creates or markets the product – it will require regular reporting by product issuers and distributors, such as financial planners, on pain of civil and criminal penalties.
The DDO marks a significant shift away from the focus on 'disclosure' that guided the financial services market since the early 2000s, but was found wanting in numerous cases of product mis-selling. The Australian Securities and Investments Commission (ASIC) was forced to act after the fact on cases such as insurance policies for products that were invalidated if a person became unemployed, or on failures associated with the issue of debentures.
Michael Mavromatis, Partner at Holley Nethercote, says the flaw with disclosure was that some issuers took the view that any risk, as long as it was disclosed, was acceptable. "The changes are, in part, aimed at issuers that were relying too heavily on disclosure when it came to addressing product-related risks," Mavromatis says. "But PDSs can be long and technical, and this has proved to be ineffective for the purposes of ensuring that consumers know what those risks are and make appropriate choices."
Onus on issuers and distributors
Instead, with the introduction of the DDO the onus for ensuring a product is appropriate for the investor shifts to the product issuer – such as fund managers who are increasingly seeking a direct-to-consumer distribution channel – and financial advisers. Products captured by the regime are very broad and include everything from managed funds to over-the-counter derivatives.
Product manufacturers will be required to demonstrate the customer-centric nature of their endeavors by having a publicly-available Target Market Determination (TMD) setting out the purpose of the product and for whom it is intended. They will have to review the product to make sure it remains consistent with the TMD, keep records of people's decisions in relation to the product, and report to ASIC any significant dealings that are not consistent with the TMD. This could include a group of people outside the TMD buying the product, or a series of dealings in the product by a particular group of consumers.
Importantly, product distribution businesses such as financial planners and advice practices have a number of obligations under the new regime, including various prescriptive reporting obligations such as the requirement to report any complaints received in relation to an issuer’s product back to the product issuer.
The DDO has been described as an insurance policy for the ‘best interest’ test that already governs advice from planners to their clients because it will ensure that products are appropriate and consumers are treated fairly. ASIC says the new laws bring "accountability" to the industry and will act in tandem with product intervention powers that allow the regulator to order changes to – or the withdrawal of – products that are unacceptable.
Increased burden on financial advisers but some relief recently granted
But the new regime has received some criticism by professional bodies such as the Financial Planning Association of Australia (FPA) for adding duplicate regulations and significant reporting requirements to the already-
Ben Marshan, Head of Policy, Strategy, and Innovation at the FPA, says that around 80% of product sales are direct from the issuer, and the DDO should be seen as the issuers pushing their obligations for the other 20% down to others like financial planners.
In mid-September, the Federal Government appeared to heed some of that criticism by agreeing to remove requirements for advisers to report to issuers when there were nil complaints or nil information. "Given this would have been the vast majority of reporting required by financial planners in relation to target market determinations, this administrative relief by the Government is a welcome outcome for the financial planning profession," Marshan says.
How to get ready for the introduction of the DDO
- Take steps to understand your obligations as a distributor of products captured by DDO.
- Ensure that each product you distribute has a Target Market Determination (TMD) and that you are familiar with their terms. Riskier products may require more detailed analysis to ensure the customer fits with the TMD.
- Ensure you take reasonable steps to ensure advice complies with the TMD. Advisers are exempted from the reasonable steps requirement when providing personal advice, largely due to the obligations an adviser has in relation to the “best interests duty”, but must still comply with the reporting and record keeping obligations. Product issuers will not want to deal with distributors who do not comply with the DDO.
- Get in touch with issuers you deal with to understand the information they require in relation to the DDO and how it should be delivered. They may request specific details such as the volume of and trends in complaints, web analytics, volumes of sales and even requests for information. "Reach out and speak to product issuers or your distribution partners about how you can practically manage these obligations," Mavromatis says.
- Be aware of different reporting demands from issuers. Marshan says one complication for advisers will be that product manufacturers may want reporting on a monthly, quarterly, or annual basis.
- Ensure processes and systems are designed and configured to deliver reporting and information in a timely and efficient manner at the required frequencies.
There may be some teething problems to begin with, but being aware of the obligations and how to comply with them before they come into effect will keep advisers on the right side of both the product issuer and ASIC. More information is available in this ASIC Design and Distribution Obligation FAQ