The implications of the new design and distribution obligations from an ECM perspective

This article was written by Joseph Muraca and Jack Hill.

As the holiday period approaches so too does the proposed release of the Australian Securities and Investment Commission's ("ASIC") draft guidance on how to implement the new product design and distribution obligations ("DDOs") that will become effective in April 2021.

To help ensure you are ready to participate in the consultation process that ASIC has flagged for that draft guidance, we have summarised the key implications of the DDOs from an equity capital markets ("ECM") perspective.

Remind me – when were the DDOs passed?

After an extensive consultation process dating back to 2017, the new DDOs and ASIC's new product intervention powers were passed just before Parliament went into recess for the federal election earlier this year. That timing was not surprising given the tail-winds for financial services regulatory reform at that time as a result of the Hayne Royal Commission.

Broadly, the legislation is aimed at improving consumer protection in relation to financial and credit products. It was proposed in response to a Financial System Inquiry recommendation that a "targeted and principles-based product design and distribution obligation" be introduced in line with a number of overseas jurisdictions.

Should I care from an ECM perspective?

Yes – if you are likely to be involved in a retail hybrid offer or a raising involving units, LITs, LICs stapled securities or preference shares that requires a regulated disclosure document. Otherwise you are in luck – the DDOs are unlikely to impact you directly once they become effective.

Key takeaways from an ECM perspective

Topic	Details
Effective date	DDOs: 5 April 2021 ASIC's product intervention powers: Effective now
Financial products caught by the DDOs	✔ Preference shares ✔ Partly paid ordinary shares ✔ Interests in an MIS (ie units in a REIT/LIT) ✔ Stapled securities ✔ Hybrid securities ✔ Corporate bonds ✔ Options (including options over ordinary shares)	✖ Fully paid ordinary shares[1]
Types of offers caught by the DDOs	✔ Initial issuances requiring a regulated disclosure document (i.e. IPOs with a retail component) ✔ Secondary raisings requiring a regulated disclosure document (i.e. where the cleansing notice regime is not used)	✖ Secondary raisings not requiring a regulated disclosure document (ie accelerated rights issues, placements, SPPs)
Product intervention powers	Not expected to have any impact from an ECM perspective as it is not currently anticipated ASIC will use its powers in connection with any standard ECM products (such as those outlined above)

What are the DDOs?

The DDOs are separated into two categories: 'design obligations' and 'distribution obligations'. The table below outlines what each of those obligations are and who will be subject to them:

Category	Who needs to comply?	Details
Design obligations	The 'issuer' or 'seller' of the financial product (i.e. the person required to prepare the regulated disclosure document for the offer of the financial product)	Before offering a financial product to investors, the issuer/seller must make a 'target market determination' ("TMD") for the product. Relevantly, that TMD must: describe the class of clients who comprise the target market for the product; set out any distribution conditions for the product; set out events or circumstances that would reasonably suggest the TMD is no longer appropriate (referred to as 'review triggers'); set out arrangements for periodic review of the TMD; and specify a number of reporting obligations for distributors A TMD must be 'appropriate', meaning that it would be reasonable to conclude that, if the product were issued or sold: to a retail client in accordance with the distribution conditions – it would be likely that the retail client is in the target market; and to a retail client in target market – it would likely be consistent with the likely objectives, financial situation and needs of the client The issuer/seller must periodically review the TMD to ensure that it remains relevant for so long as the product is on offer (this element is not particularly relevant in an ECM context given products are generally not offered on a 'rolling' basis)
Distribution obligations (Apply to 'retail product distribution conduct' which includes giving a prospectus/PDS or dealing in or advising on the product)	The 'issuer' or 'seller' of the financial product (i.e. the person required to prepare the regulated disclosure document for the offer)	The issuer/seller must: take reasonable steps that will, or are reasonably likely to, result in distribution of the product that is consistent with the TMD; and not engage in 'retail product distribution conduct' if they know (or ought reasonably to know) that a review trigger has occurred.
	Regulated persons (eg AFSL holders and authorised representatives) who engage in 'retail product distribution conduct' in connection with the product	Regulated persons must not engage in 'retail product distribution conduct' in relation to a product requiring a TMD if: a TMD has not been made; the TMD may no longer be appropriate; or they are directed by the maker of the TMD to cease that conduct while the TMD is being reviewed Regulated persons must take reasonable steps that would have resulted in, or been reasonably likely to have resulted in, 'retail product distribution conduct' being consistent with the TMD Regulated persons must also report a range of matters to the TMD maker and keep records to support those reporting obligations

I heard some changes were made just before the legislation passed – anything relevant from an ECM perspective?

Only if you do not comply with the DDOs once they become effective. In short, those changes:

extended the regime to financial products regulated under the Australian Securities and Investments Commission Act (including credit facilities);
provide a further private cause of action where an entity fails to comply with the obligation to make a TMD; and
enable a court, on application from ASIC, to make orders to benefit non-party consumers who have suffered loss or damage because of contraventions of DDOs.

Is there any practical guidance on what a TMD should look like and how to implement the DDOs?

Not yet but as noted above it is coming. ASIC has stated it will provide guidance on how to implement the DDOs and that it intends to undertake a consultation process in connection with the development of that guidance. We understand the consultation paper is likely to land before Christmas so keep an eye out.

However, if you are eager to get a sense of the direction ASIC's guidance may take, we suggest you take a look at the guidelines provided by the European Securities and Market Authority in connection with the equivalent regime in Europe. Those guidelines contain some short case studies and sample TMDs which illustrate that, at least in Europe, the TMDs should be clear and concise rather than lengthy and complicated.

Was there anything of interest from an ECM perspective in the draft regulations the Government just consulted on?

No – the draft regulations are largely consistent with the previous draft released back in 2018 with some modifications to reflect the inclusion of credit products under the DDOs.

What should I be doing now if I am going to be impacted by the DDOs?

Whether you are an issuer or a JLM, there are a number of things you can do now.

Possible action	Details
If you are an issuer, consider whether you want to be an 'early adopter' of the DDOs	Given the current environment, it is possible that your board and senior management team will be keen to explore this option It is only likely to be viable once ASIC comes out with its guidance but its never to early to start planning
Consider what the target market may look like for offers of products that would be caught	When thinking about the 'target' investor, consider what knowledge they should have about the key features of the product, what percentage of their investment they can afford to lose, what their risk tolerance is and whether the product is designed to meet their investment objectives If you are an issuer – assess the register for equivalent products you have on issue. What does it say about the average holder? Consider how your registry provider and distributors can help with this and what objective data points you can look to that support your assessment of the 'target market' If you are a JLM, speak to your distribution channels to get a clear picture of the current targets for existing products
If you are a JLM, look at your distribution channels and their compliance frameworks	If an issuer wants to early adopt, will you be ready? How are products currently sold? Are the methods being used appropriate or will they need to be updated? Will the existing frameworks and processes need to be updated to ensure distribution conditions in a TMD and reporting obligations can be complied with? How will ongoing compliance be monitored?
Think about what changes will be required to agreements between issuers and JLMs	What additional information can be sought or provided through the RFP process to help with the framing of the TMD What additional requirements will be placed on JLMs through offer management and underwriting agreements in connection with the DDOs? How will those requirements be 'passed through' distribution channels?
Be ready to engage in the ASIC consultation process	Make sure you participate in responses to how the DDOs should be implemented – it will be more difficult to inform the guidance after the consultation has closed

[1] Provided there is no intention to convert those ordinary shares into preference shares within 12 months of those ordinary shares being issued by a listed investment company.