Currently trending: Interim stop orders – ASIC’s focus on design and distribution
When we think of trending, we think of what’s popular on Twitter or TikTok, and these trends generally don’t last longer than a couple of days to a week.
When it comes to what’s “trending” in terms of regulatory matters, news on design and distribution obligations (DDO) and ASIC’s latest round of interim stop orders, appears to be one such trend, with no sign of slowing down.
Since 5 October 2021, product issuers and distributors have been required to comply with DDO (for more information on this, please refer to our previous articles – What are design and distribution product governance arrangements? and Product Design and Distribution Obligations – What you need to know). Whilst for the first 9 months, it seemed like product issuers were given some leeway from being tested on how they comply with DDO, that has all changed in the last 12 months.Since June 2022, ASIC has been hitting product issuers with interim stop orders due to alleged deficiencies in their Target Market Determinations (TMDs). Described by ASIC Deputy Chair, Karen Chester, as a “go-to regulatory tool”, ASIC has issued a large number of interim stop orders to date, and we do not anticipate this will slow down any time soon.
ASIC is actively checking whether or not product issuers and distributors appear to be complying with DDO, and will not hesitate to take action where it believes there are deficiencies. As such, it is important that licensees address any potential shortfalls in their product governance arrangements and TMDs.
ASIC’s most recent focus
ASIC’s initial review of product issuers and DDO compliance largely focused on investment products, but ASIC has since also focused on other areas including insurance.
ASIC’s review of the DDO practices of investment product issuers prompted it to release Report 762 Design and distribution obligations: Investment Products (Report 726). Report 762 outlines the findings of ASIC’s review into issuers of investment products between October 2021 and May 2023.
Whilst the review was specific to investment products (largely registered managed investment schemes), the key findings can easily be adapted to other financial and credit products. ASIC has noted that further scrutiny of DDO is coming, and with more industries coming into ASIC’s focus, it is extremely important that product issuers address any issues before ASIC comes knocking.
ASIC has also stated that it will place more focus on how product issuers interact with their distributors to ensure they are not straying beyond their target market, and how it will monitor and review product governance arrangements and suitability for retail clients.
Deficiencies in TMDs
A quick review of Report 762, alongside a review of the interim stop orders issued by ASIC to date, reveals ASIC’s views that deficiencies and issues are common across the investment industry.
Many of the alleged deficiencies noted by ASIC focused on TMDs not taking into account the objectives, financial situation, and needs of consumers in an objective manner.
It is therefore important that when preparing your TMD and determining whether your products are appropriate, that you correctly note the features of your offer and how this relates to the objectives, needs and financial situation of your target market.
So, what were the biggest problems identified by ASIC during its initial review of DDO?
1. Target markets being defined too broadly
To ensure your target market is correctly defined, you should ensure that you appropriately consider the financial situation, objective and needs of customers in your target market when preparing your TMD.
One example raised by ASIC included an issuer that described a product that generated little to no income distributions, as being potentially appropriate for clients seeking income.
2. Unsuitable investor risk profile
This would occur where issuers of high-risk products understood the risk level of their products to be high but included clients with a medium-risk profile in their target market. An unsuitable risk profile was a factor in 30 of the 36 stop orders that had been issued by ASIC as at that date.
3. Inappropriate levels of portfolio allocation used
A factor identified in half of the stop orders issued by ASIC was that product issuers were incorrectly apportioning the asset allocation of high-risk products for customer portfolios. Examples of this may include where an investor was recommended an asset allocation of 75% for a single high-risk product (where 10% may have been more appropriate).
Further, some product issuers overstated or assumed a level of diversification in customer portfolios when it wasn’t there. ASIC stated that when preparing TMDs, product issuers should consider investment products on a stand-alone basis, and not assume they will form part of a diversified portfolio.
4. Unsuitable investment timeframes and/or withdrawal features
Unsuitable investment timeframes or withdrawal features were a factor in 26 of the 36 interim stop orders. For example, a client seeking “annual or longer” withdrawal rights was in the target market for a product that did not have any withdrawal rights before the end of the fixed term.
Another example of this could include where products suited to a short investment time frame (such as CFDs) are described in a TMD as being aimed at clients who seek a 1-3 year investment timeframe – which is not consistent with the product’s key attributes.
5. Distribution conditions
The distribution conditions of the product issuer were a factor in 14 of the 36 stop orders that had been issued by ASIC at the time of the report.
Issuers must specify distribution conditions in their TMDs, which as identified in Report 762, some issuers did not include.
Further, a product issuer must also take reasonable steps that will, or are reasonably likely to, result in distribution being consistent with the TMD. Report 762 identified that some product issuers relied on consumer self-certification that they were in the target market, which was inconsistent with the objectives of DDO.
We anticipate that ASIC will continue to look at the TMDs of various product providers over the next few months, so it is very important that distribution conditions (and all other requirements) are correctly outlined within the TMD.
6. Over reliance on template TMDs
Whilst templates are a very useful tool in preparing your TMD, product issuers need to ensure they adapt and tailor templates to meet the specific requirements of their clients and their products.
ASIC identified 13 cases where a template was inappropriately used by product issuers, resulting in an interim stop order being issued. This included a lack of customisation, or an inappropriate template being used (for example, one that was not suitable to the product offering or client needs). Therefore, when utilising a template, it is critical that you make it your own, and customise the template to be relevant to your products.
For further information and tips on how you may be able to improve your TMD, refer to our fact sheet on the Top 5 Tips for Target Market Determinations.
Author: Josh Wigney (Lawyer)