5 October 2024 will mark the third anniversary of the commencement of the design and distribution obligations regime (“DDO”). ASIC has enforced the DDO regime vigorously since its inception, with 88 interim stop orders having been issued to date and several legal proceedings having been brought by ASIC. ASIC’s DDO focus in 2022 to 2023 centred on the appropriateness of content included in target market determinations (“TMDs”). DDO remains an enforcement priority for ASIC. However, ASIC has now signalled a focus on the “reasonable steps” that underpin the TMD itself.
ASIC’s Report 795 – Design and Distribution Obligations: Compliance with the Reasonable Steps Obligations (“REP 795”) includes useful commentary on ASIC’s expectations in relation to the reasonable steps obligation, and contains examples of best practice. It is a timely reminder of the need for issuers and distributors to scrutinise the effectiveness of their arrangements for compliance with the “reasonable steps” obligation.
Overview of the DDO regime
Under the DDO regime, issuers of in-scope financial products must prepare a TMD that identifies a class of consumers for whom the product would likely be appropriate. Issuers and distributors must also take “reasonable steps” that are reasonably likely to result in the financial products reaching the target market.
ASIC has been vigorous in its enforcement of the DDO regime since it took effect in October 2021. Its initial enforcement action centred on TMD content requirements. To date, this has resulted in approximately 28 interim stop orders as in respect of deficient TMDs, stopping product issuers from offering their financial products to consumers until those deficiencies were addressed. ASIC also released Report 770: Design and distribution obligations: Retail OTC derivatives and Report 762: Design and distribution obligations: Investment products, summarising key observations as to areas for improvement in respect of TMD content requirements.
However, ASIC has recently signalled a particular focus in relation to the “reasonable steps” obligation. This has been evident from ASIC’s comments in its enforcement and regulatory update in Report 794: ASIC enforcement and regulatory update: January to June 2024, as well as its comments in REP 795.
Key learnings from REP 795
REP 795 outlines the findings from ASIC’s review of 19 issuers of “high-risk” investment products, accident and funeral insurance, and medium amount credit contracts. It also centred on whether issuers were taking “reasonable steps” that were reasonably likely to result in the financial products reaching the relevant target market.
Although the report found a broad awareness of the “reasonable steps” obligation, and that all issuers had policies and procedures in place to comply with this obligation, ASIC identified a number of areas for improvement, as well as examples of best practice.
IDENTIFIED AREA OF IMPROVEMENT
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Example
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1. Selection and supervision of distributors |
ASIC highlights that conducting basic due diligence on distributors is unlikely to be sufficient to discharge the reasonable steps obligation. Best practice involves undertaking due diligence as to the distributor’s actual capacity to comply with the DDO regime. Although the DDO regime does not require “formal arrangements” between issuers and distributors, entry into formal arrangements may support compliance with the DDO regime. Consistent with ASIC’s comments in REP 770 and REP762, ASIC remains critical of compliance approaches based on “self-certification”. |
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2. Training staff |
To be effective, training needs to go beyond generic training about product features – it should “cover the connection between features and the target market”. Best practice involves tailored training for specific roles in relation to the relevant product, and updates or refreshers where the TMD or product has changed. ASIC has highlighted that scripts can be useful in driving consistency. |
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3. Marketing and promotional materials |
ASIC was critical of the use of broad search terms (such as “loan”) to target customers using online marketing. ASIC was also critical of mass market advertising such as sponsoring high profile sports teams, and inadequate oversight over website design features (such as “gamification”) that are used to engage with customers. |
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4. Use of questionnaires |
In its only final stop order, ASIC was critical of poorly designed and inadequate questionnaires. Questionnaires can form part of the “reasonable steps” used to assess whether a consumer is reasonably likely to be in the target market. However, ASIC cautions against over-reliance on questionnaires, and gives a number of examples in REP 795 of deficiencies in questionnaires it has reviewed. These include “leading” and “unbalanced” questions, pop-up “warnings” stating that certain answers would result in the consumer not being captured by the TMD, and questions that are difficult to understand. Best practice includes using plain language, avoiding “double-barrelled questions” and undertaking testing and professional validation of questionnaires. |
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5. Use of information and monitoring outcomes |
ASIC has emphasised the importance of adopting a “data-driven” approach to compliance with the DDO regime on a number of occasions (including in RG274). In REP 795, ASIC highlights the importance of using existing information held about consumers to assess whether they are likely to be in the target market (such as information held about the circumstances of the consumer, web analytics or reasonable inferences from data). Best practice not only involves analysing and applying this information, but also monitoring outcomes from the product, such as reviewing flow of funds to detect unusual activity or excessive losses. |
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Interim Stop Orders: Quality of Questionnaires in Focus
During the course of the review to which REP 795 relates, ASIC issued four interim stop orders stemming from concern about compliance with the reasonable steps obligation.[1] Notably, all four orders related to issues with the design and content of questionnaires given to consumers as part of the target market assessment.
ASIC’s key concerns in issuing the stop orders included:
- not adequately inquiring into consumer’s risk tolerance, financial situation, and technical understanding of the products;
- design flaws, such as prompting users to review ‘unacceptable’ answers that were likely to put them outside the target market;
- follow-up communications providing consumers the opportunity to amend their responses to fit within the target market; and
- allowing unlimited opportunities to complete the questionnaire.
This adds to the 83 interim stop orders, and one final stop order, that ASIC had previously issued in relation to DDO since their introduction.
https://asic.gov.au/about-asic/news-centre/find-a-media-release/2024-releases/24-109mr-asic-issues-ddo-stop-orders-against-trademax-australia/; https://asic.gov.au/about-asic/news-centre/find-a-media-release/2023-releases/23-141mr-asic-issues-first-ddo-stop-order-for-failure-to-take-reasonable-steps-in-cfd-distribution/; https://asic.gov.au/about-asic/news-centre/find-a-media-release/2024-releases/24-120mr-asic-issues-ddo-stop-order-against-australian-unity-funds-management/