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Wednesday 3 May 2023

23-115MR ASIC calls on investment product issuers to ‘lift their game’ on design and distribution obligations

ASIC today called on investment product issuers to ‘lift their game’ after an initial review found significant room for improvement in how they meet their design and distribution obligations (DDO).

The DDO, now into its second year, marks a significant shift to outcomes-based regulation. Ultimately, it requires financial products to be designed and distributed with clear and contemporary consideration of the objectives, financial situation and needs of the consumers and retail investors being targeted.

‘The design and distribution obligations are a ‘game changer’ for consumers and retail investors. Companies need to take a consumer-centric mindset across a financial product’s lifecycle. The DDO interim stop orders have become a ‘go-to regulatory tool’ for ASIC to quickly disrupt and stem poor consumer outcomes,’ ASIC Deputy Chair Karen Chester stated.

ASIC undertook an initial, risk-based review of how investment product issuers are meeting the DDO. Report 762 Design and distribution obligations: Investment products (REP 762), released today, outlines the review findings and actions taken by ASIC in response. The review found that a significant number of the product issuers[1] made deficient target market determinations (TMDs), with poorly defined target markets and unclear or inadequate product governance arrangements.

‘Investment product issuers have been on notice to meet the design and distribution obligations since October 2021. It is disappointing to see DDO deficiencies across the board, and by large and small product issuers alike.

‘Poor product design or distribution puts retail investors at risk of financial harm, ending up in products that don’t meet their needs. The fact that we have issued 26 stop orders on investment products in just nine months shows that product issuers need to ‘lift their game’ – and now,’ Ms Chester said.

ASIC prioritised the initial review of investment products because of concerns that investors were being inappropriately exposed to high-risk products. The key target market deficiencies ASIC identified across investment product issuers include:

  • target markets defined too broadly – a factor in 15 stop orders;
  • unsuitable investor risk profiles used – a factor in 21 stop orders;
  • inappropriate levels of portfolio allocation used – a factor in 10 stop orders; and
  • unsuitable investment timeframes and/or withdrawal features, not reflecting the product’s risks and liquidity profile – a factor in 18 stop orders.

ASIC also identified inappropriate or no distribution conditions – a factor in 13 stop orders.

Many of these deficiencies appeared when issuers relied on TMD templates without customising them appropriately.

As a result, ASIC placed interim stop orders on 26 investment products from 18 issuers since 1 July 2022, representing $6.6 billion in funds invested by retail investors. These actions by ASIC resulted in 12 issuers amending 18 TMDs to address the deficiencies and five issuers withdrawing seven products.

ASIC also reviewed the product design arrangements of 12 issuers of around 640 registered managed investment schemes to check how they met the ‘reasonable steps’ and TMD review obligations. ASIC found a prolific use of investor questionnaires to meet the ‘reasonable steps’ obligation without a clear underlying governance and distribution framework. While all issuers had arrangements to meet their TMD review obligations, they needed to use review triggers more effectively and improve their processes upon a review trigger.

‘Closer scrutiny of DDO is coming,’ Ms Chester said. ‘All investment product issuers should read our report, assess their practices, and address any gaps informed by our findings. In coming months, ASIC will begin to review how product issuers interact with their distributors to ensure they are not straying beyond their target market, how they monitor product governance arrangements and review data to ensure retail investors are receiving suitable products on an ongoing basis.

‘We won’t hesitate to take further action, from stop orders through to court proceedings, especially where we see egregious failures. We have already commenced civil penalty proceedings for alleged DDO breaches against a distributor of an investment product and an issuer of a credit product.  We have further stop orders under consideration and several other DDO-related investigations underway,’ Ms Chester concluded.

Download

Report 762 Design and distribution obligations: Investment products

The report includes links to all the investment product-related interim stop order media releases.

Background

DDO requires financial product issuers and distributors to ensure products are designed with consumer needs in mind and distributed in a targeted manner. Financial product firms are also required to monitor outcomes and reassess their product governance arrangements over time. A TMD is a mandatory public document (under DDO) that sets out the class of consumers a financial product is likely to be appropriate for (target market) and matters relevant to the product’s distribution and review.

ASIC took stop order action on 11 issuers of managed investment scheme with a total of approximately $6 billion in funds under management and 7 issuers of other investment products who sought to raise $609 million from investors. Issuers that were the subject of ASIC’s interim stop orders for DDO breaches include among others: BT Advance Asset Management, Perpetual Investment Management, MPG Funds Management, and Fawkner Property Limited. See the full list in REP 762.

To date, ASIC has undertaken, or is undertaking, risk-based surveillances in relation to buy now pay later, credit cards, derivatives, investment products, small amount credit and superannuation. ASIC has:

  • made additional interim stop orders in relation to credit (23-031MR) and derivatives (refer 23-056MR) (bringing the total number of DDO stop orders to 28);
  • caused 9 issuers to withdraw 11 products from the market;
  • released surveillance findings in relation to small amount credit contracts (22-352MR) and superannuation (22-236MR); and
  • commenced civil penalty proceedings for alleged DDO breaches against Firstmac Limited, a distributor of a managed investment scheme (22-361MR), and American Express Australia Limited, an issuer of a credit product (22-338MR).

Regulatory Guide 274: Product design and distribution obligations (RG 274) sets out expectations for compliance and ASIC’s approach to administering the obligations.

 

[1] Issuers of managed investment schemes and other products, such as shares issued by an investment company, preference shares and debentures.