Case study - Applying design and distribution obligations to ETOs
Exchange Traded Options (ETOs) are standardised products authorised for trading by the ASX, a licensed market operator. The design and distribution obligations require firms that prepare a PDS for products (such as ETOs) to define the target market by assessing the product and the likely consumer objectives, financial situation, and needs for which the product (including its key attributes) is likely to be appropriate. The target market and distribution settings (e.g. distribution conditions and review triggers) will be contained in a target market determination (TMD). Issuers and distributors of ETOs will be required to take reasonable steps to distribute ETOs in accordance with the TMD.
ETOs are often traded frequently, meaning there are regular issuances triggering the reasonable steps obligations under section 994E(1) and (3) of the Corporations Act 2001. In meeting its reasonable steps obligations, ASIC would not expect it would be necessary for an ETO issuer to conduct an individualised assessment of a client prior to every ETO trade, where it has robust and effective ongoing product governance arrangements in place.
The reasonable steps obligations under the design and distribution obligations require firms to adopt a risk management approach. This allows the issuer to consider all relevant factors in determining what steps to take to reduce the risk of the product being distributed in a way that is inconsistent with the TMD for the product, having regard to the circumstances. Importantly, reasonable steps may not look the same in all circumstances and this is reflected in Regulatory Guide 274 Product design and distribution obligations (RG 274).
We expect ETO issuers and distributors will already have in place internal risk procedures and controls to assist them in meeting their reasonable steps obligation, including those used for client monitoring. For example, stress testing, the imposition of additional collateral requirements or other controls designed to limit the client’s exposure. ETO issuers would also have existing onboarding processes that can be adapted as necessary to assist them in meeting their reasonable steps obligation.
Where an issuer or distributor has onboarded a client prior to 5 October 2021, these current controls and processes may provide the issuer or distributor with enough information to meet their reasonable steps obligations on whether the existing client is within the target market. For example, where the client has a satisfactory trading history and has met their margin and other obligations in relation to the ETO, the issuer or distributor may already have sufficient information to determine that the client is reasonably likely to be in the target market for ETOs, and may do so without having to ask further, specific questions of the client.
Importantly, ASIC expects issuers and distributors to monitor consumer outcomes and regularly review their product governance arrangements to ensure they remain effective.
While the case study is not intended to provide exhaustive guidance, it highlights some areas that may assist firms that issue and distribute ETOs. For more detailed guidance, issuers should consider RG 274.