ASIC strengthens its design and distribution regime guidance
15 May 2023
What you need to know
- In its May 2023 report on compliance with DDO obligations by issuers of investment products, ASIC concludes that there is considerable room for improvement in complying with the obligations under the regime.
- In the report, ASIC summarises its findings on TMDs following its initial compliance review of the investment product industry, and its issue of 26 interim stop orders.
- ASIC comments that issuers should use templates that are suitable for the investment products they issue, and customise them for their investment products.
- ASIC states that issuers must specify distribution conditions in their TMDs and those distribution conditions should be tailored for each product.
- ASIC also makes observations in its report about product design, distribution and oversight, and monitoring and review arrangements. There are a range of steps which ASIC expects organisations to take to meet their reasonable steps obligations, including gathering evidence that distributors are meeting their obligations and implementing proper oversight of product distribution and performance.
- ASIC highlights the need for issuers to continuously monitor design and distribution issues and ensure Board involvement in oversight of an organisation's compliance arrangements.
What you need to do
- Investment product issuers should read the report, assess their practices and address gaps identified.
- When assessing DDO processes and practices we advise that product issuers:
- review and ensure that product governance arrangements are well-documented, and are effectively implemented and embedded in practice
- test the adequacy of defined TMD review triggers through scenario and data analysis to ensure they enable the proactive identification of potential customer harm
- define and include distribution conditions in TMDs where there are none
- review arrangements with distributors and the process which is used to oversee their compliance with distribution conditions
- review committee and Board agendas, and the adequacy of reporting, to strengthen the quality of engagement on DDO outcomes
- provide training and guidance to all stakeholders involved in the product lifecycle to ensure they understand how to practically apply DDO requirements in their roles
Background
In 2022, ASIC reviewed compliance with the design and distribution obligations by issuers of investment products (including interest in managed investment schemes (MIS), shares issued by an investment company, preference shares and debentures). On 3 May 2023, ASIC issued a report containing its key observations on how issuers in investment products are meeting those obligations and highlights areas for improvement as well as identifying good practices that have been adopted by some issuers in relation to compliance with DDO.
Regulatory action
Since July 2022 ASIC has issued 26 stop orders on 11 issuers of interests in managed investment schemes and 7 issuers of other investment products on the basis that there were breaches of the TMD requirements by the issuers of those products. ASIC's enforcement action was taken in relation to a range of investment products from those with niche alternative investments, to those that offered exposure to more traditional investments such as listed equities.
TMD deficiencies
The key TMD deficiencies and areas for improvement identified by ASIC were focused on target markets being defined too broadly. This included the lack of customised use of TMD templates and inappropriately defining the characteristics of customers in the target market, such as their risk profiles, portfolio allocation, intended investment timeframe and withdrawal needs.
ASIC also wants issuers to avoid using the Standard Risk Measure (SRM) as the sole means by which the risk of a product is assessed. It asks issuers to consider other risk factors such as the level of leverage and withdrawal limitations in setting a product's risk rating.
Distribution conditions
In ASIC's view, issuers must specify distribution conditions in their TMDs. ASIC gives some examples of the types of distribution conditions they have observed: however the problem remains for product issuers that many do not hold data about their customers that would enable them to craft distribution conditions having regard to particular types of customers.
Issuers will now need to consider what types of distribution conditions may be suitable, having regard to the nature of the product being issued and the types of customers that are likely to seek access to it. ASIC has confirmed that customer self-certification of being in the target market is not sufficient as a distribution condition.
ASIC seeks improvements in the steps taken by issuers in relation to the reasonable steps that will or are reasonably likely to result in the distribution of a product being consistent with the product's TMD. ASIC has flagged that future surveillance work will focus on compliance with the reasonable steps obligation and that it will consider regulatory action where necessary.
Distribution strategy and the sales process
ASIC confirms that it is good practice for issuers to use information collection tools to draw out the objectives, financial situation and needs of customers, which may be useful information as one part of an overall distribution strategy to meet the reasonable steps obligation. On the other hand, ASIC wants issuers to consider that questionnaires are only one component of an issuer's distribution strategy and sales process, and ensure that questions asked of a customer are appropriate and do not amount to self-certification by a customer.
ASIC observes that some issuers were adopting good practices such as using key words to drive search engine optimisation that was consistent with the target market, and undertaking checks of all marketing and promotional material to ensure that it aligns with the TMDs and would make it more likely for customers outside of target market not to invest in the scheme.
Use of third party distributors
ASIC commented that most issuers of interests in managed investment schemes that it reviewed used third party distributors including platform providers, sales staff or financial advisers to provide general advice.
ASIC confirms the need for issuers to access the capacity of distributors to comply with distribution conditions and meet DDO obligations more broadly by strengthening their communication and oversight arrangements with distributors.
ASIC reinforces these observations by commenting that areas for improvement are
- having issuers gather evidence that distributors are meeting the obligations (rather than relying on self-certification)
- requiring more detail from distributors on compliance practices, and
- undertaking audit or verification whether a distributors statement about their compliance practices were followed in practice.
Monitoring and supervision arrangements
ASIC expects issuers to maintain adequate monitoring and supervisory arrangements in relation to the distribution of products. It commented on issuers maintaining documented design and distribution policies and specialised committees for review of DDO compliance.
In particular, ASIC calls out that issuers should consider whether other documented processes, controls and systems are needed to ensure compliance with the TMD and other DDO obligations. It expects issuers to continuously monitor and respond to ongoing design and distribution issues (not just at product launch), and also that issuer Boards should ensure that the organisation has ongoing and adequate oversight of the business product governance, distribution and review arrangements.
Periodic and trigger reviews of TMDs
ASIC notes that the issuers reviewed had arrangements in place to identify when a review trigger or other event or circumstance suggested a TMD was no longer appropriate. However, it comments that some issuers reviewed had triggers which lacked specificity and required more detail.
ASIC makes a number of findings in relation to areas of improvement around conducting periodic or reactive reviews of TMDs. At a high level, ASIC comments that issuers should consider tailoring their review framework to best ensure they can identify areas of likely customer harm and changes required to the scheme or TMD. It expects issuers to test whether distribution arrangements and conditions remain adequate and appropriate including by assessing distribution channels and analysing distribution outcomes.
For reactive reviews, ASIC recommends that reviews be tailored to meet the nature of the issue that triggered the review (eg matters raised in complaints). ASIC also comments that issuers should consider whether a scheme may need to be removed from the market altogether due to significant customer harms (indicating that issuers should factor into their policies and processes a mechanism for considering whether or not this is required).
What now?
Investment product issuers should review the report and perform a gap analysis against the findings. With the multiple number of focus areas highlighted in the report, it is important that issuers review the adequacy of the foundations of their product governance arrangements to ensure that any gaps are not only effectively addressed, but become well-embedded.
| 1. Uplift product design and distributor oversight mechanisms | The specific gaps identified in the report highlight a need to review the adequacy of product governance arrangements from end-to-end. A common pitfall with the implementation of the regime was that while procedural and control documentation relating to product design and distributor oversight processes were developed, the ongoing effectiveness of these new procedures has often been challenged due to gaps in accountability, and ongoing review and monitoring. This has also often been compounded by the limited availability and use of data relating to customer and product outcomes. In addition to reviewing their existing TMDs, issuers should update their product design processes, controls and systems to ensure that the development of TMDs for any new products adequately capture the additional considerations noted by ASIC. This should additionally include providing greater direction to distributors in how they engage with and understand customers as part of directing products towards the appropriate target market, by appropriately defining distribution conditions as required by the regime. |
| 2. Strengthen Board and management oversight | ASIC observed that Board and management committee involvement with product governance arrangements has tended to be limited to the development of TMDs. Issuers should establish processes and systems to enable adequate ongoing challenge by the Board and management over the product lifecycle. In addition to creating time in meeting agendas, this should include establishing appropriate reporting to the Board and management to support their ability to provide insightful challenge, which should include monitoring key customer metrics and the effectiveness of controls in demonstrating how products are distributed in a compliant manner. ASIC has stated that the ultimate aim of the DDO regime is to ensure that the right customers are taking out the right products and it expects the monitoring and oversight framework adopted by product issuers will align with this objective. |
| 3. Staff capability and training | Having capable Product Development, Distribution and Marketing staff is critical to being able to effectively address the gaps identified by ASIC. Staff training provided during the initial implementation of the regime often provided a cursory overview of the DDO requirements. Additionally, learnings about customer and product outcomes were often not used as inputs into refreshing training to support the continued and ongoing development of DDO expertise. ASIC's report highlights the importance of ensuring that training content is tailored to the relevant teams, and to provide them with the ability to practically apply the learnings in developing products and TMDs, and engaging with customers. Issuers should review the content and cadence of training that is provided to relevant teams to ensure that any new or current staff are equipped with and can continue to build on the ability to address ASIC's heightened expectations. |
In order to effectively achieve the outcomes of the regime, organisations should ensure that the compliance practices associated with their product governance arrangements do not operate in isolation.
They should consider how DDO compliance arrangements can be integrated with their broader organisational risk and compliance frameworks, while also acting on opportunities to enhancing DDO outcomes through the effective implementation of adjacent regulatory changes, such as the upcoming Financial Accountability Regime.
Authors: Lisa Simmons, Partner; Gwladys Ngo Tedga Yagla, Partner (Ashurst Risk); Meera Ghelani, Director (Ashurst Risk) and Chris Tran, Executive (Ashurst Risk)
