Where firms are getting TMDs wrong, and what better prepared firms are doing differently

Several years on from the introduction of the design and distribution obligations (“DDO”) regime in October 2021, the central challenge that product issuers face remains to be defining their target market and screening clients against the defined target markets for their financial products.

While most financial services firms now have Target Market Determinations (“TMDs”) in place, the Australian Securities and Investment Commission (“ASIC”) feedback to several financial services industries continues to be that, in ASIC’s view, many product providers treat their TMD as a one-off drafting exercise rather than as a dynamic framework that is actively shaped by the data it receives over time as it issues the product to retail clients and wholesale clients alike.

Recent developments

As set out in ASIC Report 828 – Risk business: Driving change in CFD issuer’s distribution practices (“ASIC Report 828”), ASIC signalled that, in respect of CFD issuers, ASIC found that (among other things) many issuers failed to adequately describe key attributes of clients within their target market; had ambiguous descriptions in their TMDs; some relied on TMD templates that were not suited for complex high-risk products; and very few had amended their TMDs despite ASIC publishing its views in ASIC Report 770 Design and distribution obligations: Retail OTC derivatives (“REP 770”).

In one instance, this resulted in ASIC issuing a stop-order against one CFD issuer who inappropriately included investors with a medium risk appetite in the target market for its CFD products.

Separately, the Federal Court of Australia ordered American Express Australia Limited to pay $8 million in penalties for breaching DDO requirements.

ASIC alleged that Amex ought to have known high cancelled application rates reasonably suggested that the TMDs were no longer appropriate, and failed to stop issuing the credit cards when it had not reviewed the TMDs.  This reiterates the importance of utilising the information and data produced from issuing the product to clients to determine whether or not the product is, as a matter of fact, being consistently distributed to clients that are within the target market as defined within the TMD.

What kind of monitoring and review framework do you have in place?

In proceedings involving Firstmac Limited, the Federal Court found Firstmac’s review processes to be inadequate and that they lacked sufficient systems, policies, practices and procedures to address identified, or reasonably identified, risks that its retail product distribution conduct was inconsistent with its TMD.

The Court held that this conduct fell far short of the standard of behaviour expected of a reasonable person in Firstmac’s position, particularly in light of the steps it could have taken to eliminate or minimise the likelihood of non-compliance with the TMD,[1] resulting, again, in penalties totalling $8 million for failing to comply with the DDO requirements.

This highlights the importance of having a robust internal review process for your TMD that accommodates for the many triggers that may indicate that the target market as described in the TMD is either too broad or too narrow.  Australian Courts have now, on two occasions, imposed significant penalties of $8 million in circumstances where those entities failed to take reasonable steps to comply with the DDO requirements.

“What things can I do to ensure that I’m complying with the DDO requirements?” I hear you ask…

Tips to consider when preparing, reviewing your TMD

TIP 1: Check the data – Reviewing the data and internal information produced from the distribution of your financial products to your clients will provide you with vital information in determining whether or not your product is being distributed to the intended target market or if there are any patterns emerging that might serve as a trigger to prompt a review and amendment of the TMD.

TIP 2: Train your staff – Your staff are often working in front-line roles and regularly dealing with clients to whom your financial products have been distributed. Therefore, they will also be a first-point of contact for any complaints received, or be in position to identify any common themes or triggers that might indicate that a review of your TMD is required (e.g. the product is frequently being distributed to clients outside the defined target market, or the product is being distributed to people who are in the target market but perhaps shouldn’t be – indicating that the target market may be too broad, etc.).  Effective training should not be limited to the initial rollout stage of the product.  We recommend conducting ongoing training when changes are made to the product, TMD or a related policy that governs the product.

TIP 3: Talk to your distributors – Your distributors are valuable sources of information and have legal obligations to inform you of certain information that may require you to review and/or amend your TMD.  Keeping in frequent contact with them will allow for greater information transparency and will assist in demonstrating that you have been taking reasonable steps to ensure that you comply with the DDO requirements.  It will also ensure that, if there are any changes made to a TMD for a particular financial product, that your distributors are made aware of it which in turn reduces the risk of the financial product being distributed to people that are no longer within the target market (if that was the particular amendment made).

If your TMD needs to be reviewed and you are unsure if it remains fit for purpose and suited to your financial product, you can get in touch with us to assist you in reviewing and/or amending your TMD to comply with the DDO requirements.  We also have a great TMD template and related tools, which can be tailored to your specific financial product and can be purchased from the HN Hub if needed.

Please contact our office if you would like to discuss TMDs or any DDO requirements with one of our lawyers.

Author: Glenjon Aligiannis (Senior Associate)

[1] Firstmac at [209].