Watch your (reasonable) steps! ASIC crackdown on distribution practices and updated guidance on DDO

ASIC has warned product issuers to revisit their distribution practices after reviewing industry compliance in its latest design and distribution obligations (DDO) surveillance report released on 10 September 2024, Design and distribution obligations: Compliance with the reasonable steps obligation (Report 795).

Report 795 is a shot across the bow for issuers to take preventative action now. Focusing on compliance with the “reasonable steps obligation” in DDO, ASIC recommends that issuers improve their distribution practices in the following areas:

• selection and supervision of distributors;

• training staff;

• marketing materials;

• consumer questionnaires; and

• information and monitoring outcomes.

This article summarises ASIC’s findings in Report 795 and identifies the steps issuers should take to meet ASIC’s compliance expectations.

DDO recap

The DDO regime in Part 7.8A of the Corporations Act commenced on 5 October 2021.

DDO is a move away from a disclosure-based scheme of consumer protection to a “protection by design” model, which places additional responsibility on issuers and distributors of financial products.

The DDO regime requires financial product issuers and distributors to develop and maintain effective product governance arrangements across the life cycle of financial products.

It imposes a number of obligations on issuers and distributors, including for issuers to make a target market determination (TMD), to review the TMD and cease issuing the product where circumstances or events reasonably suggest the TMD is no longer appropriate, to take reasonable steps to ensure “retail product distribution conduct” is consistent with the TMD, and to keep records regarding the TMD.

What is the “reasonable steps obligation”?

Issuers and distributors must take reasonable steps that will, or are reasonably likely to, result in distribution of a financial product being consistent with the TMD. This is known as the reasonable steps obligation (RSO).

Issuers and distributors should therefore adopt a risk management approach and take steps that are reasonably likely to reduce the risk of a product being distributed in a way that is inconsistent with the product’s TMD.

Issuers and distributors need to consider whether their distribution methods and other matters could affect whether consumers are receiving a product consistent with their likely objectives, financial situation and needs. Factors for consideration include:

• the risk profile of the product;

• channels of distribution;

• marketing methods and content; and

• sales practices.

ASIC enforcement

ASIC has been active in enforcing DDO since it commenced in October 2021. DDO was named as one of ASIC’s 4 strategic priorities in its last annual report.

Enforcement action by ASIC to date has mainly been through the exercise of its administrative power to issue stop orders on the sale of products when it thinks there is non-compliance. In the 22-23 financial year ASIC issued 78 of these stop orders.

Recently ASIC has gone a step further by taking firms to court over their DDO practices.

We’ve published case note summaries on our website about some of these cases:

• ASIC v Firstmac Limited [2024] FCA 737

• ASIC v American Express Australia Limited [2024] FCA 784

• ASIC v Bit Trade [2024] FCA 953

ASIC’s initial DDO focus was on whether issuers had TMDs for their products and whether the TMDs were properly identifying the target market.

The regulator’s focus has now moved toward how issuers and distributors comply with the RSO so that products are being properly distributed to consumers in the target market.

Report 795

Report 795 details the results of an ASIC surveillance on compliance with the RSO, across multiple industries and products. Among the 19 issuers reviewed by ASIC:

• 18 were a distributor for their own products;

• most distributed their products via their websites;

• some used call centres, particularly issuers of funeral and accident insurance;

• some issuers of accident insurance and registered schemes used financial advisers to distribute their products; and

• all used questionnaires or knockout questions to identify whether or not customers were reasonably likely to be in the target market.

How did issuers do?

Of the issuers studied in the report, ASIC took action via a stop order or concerns letter in 47% of cases, resulting in changes to the issuers’ compliance with the RSO.

During the surveillance project, ASIC issued 3 DDO stop orders, all related to reliance on poor-quality questionnaires. These stop orders were against:

• Trademax Australia concerning contracts for difference;

• Australian Unity Funds Management concerning issuing interests in a select income fund to retail clients; and

• Mitrade Global Pty Ltd concerning contracts for difference.

The stop orders were revoked after the entities made changes to their questionnaires and compliance with the RSO.

ASIC raised issues of concern with 6 other issuers who agreed to make changes to policies and procedures to improve their compliance with the RSO.

Key findings and recommendations in Report 795

ASIC found that issuers needed to do more to comply with the RSO. ASIC identified the following shortcomings:

• limited due diligence arrangements to assess and monitor third party distributors;

• some issuers of high-risk products used broad search terms for online marketing;

• poor quality questionnaires; and

• limited monitoring of consumer outcomes.

ASIC recommends that issuers review Report 795, particularly some of the “better practices” and consider whether they need to change their distribution practices for:

• selection and supervision of distributors;

• training staff;

• marketing and promotions materials;

• use of questionnaires; and

• use of information and monitoring outcomes.

There are a number of detailed findings in Report 795 relating to each of these areas and we have set them out in a summary table which you can download here.

Integrate DDO into your enterprise framework

Issuers should consider how to integrate DDO (including the RSO) into their broader governance and compliance frameworks. ASIC observed in Report 795 that when framing their “reasonable steps”, issuers need to consider how different distribution steps interact with each other throughout the product life cycle, and how different distribution channels require different compliance, training and monitoring responses. One size does not fit all.

ASIC noted with approval the decision of the Federal Court in the Firstmac case (see our case note here), which held that that an assessment of whether an entity had taken reasonable steps requires a “holistic analysis that considers the full framework of an entity’s contracts, policies and procedures” (at [50]) and concerns whether an entity has “put in place adequate systems, policies, practices, and procedures – including a process of oversight and supervision – to address identified or reasonably identifiable risks of retail product distribution conduct which was inconsistent with the TMD” (at [55]).

RG 274 update

In conjunction with the release of Report 795, ASIC has also updated its Regulatory Guide 274 Product design and distribution obligations (RG 274), mainly to clarify its guidance on the product appropriateness requirements under DDO. The appropriateness requirements are that it must be reasonable to conclude that:

• the product, including its key attributes, is likely to be consistent with the likely objectives, financial situation and needs of consumers in the target market; and

• the distribution conditions make it likely that the consumers who acquire the product will be in the target market.

ASIC has also published a summary of the changes. ASIC says that these changes will not require product issuers to update their TMDs.

The updated guidance clarifies that the TMD does not have to include information about the appropriateness of a product to demonstrate that the appropriateness requirements have been met. This is because the appropriateness requirement is an objective test. However, updated RG 274 reminds that an issuer must keep records of its decisions and reasons for its decisions in relation to the appropriateness requirements.

ASIC encourages issuers to explain in the TMD why the product, including its key attributes, is likely to be consistent with the likely objectives, financial situation, and needs of consumers in the target market.

As to distribution, the issuer must still specify in the TMD appropriate conditions and restrictions on distribution of the financial product, but the TMD does not need to say why those conditions and restrictions will make it more likely that the consumers who acquire the product are in the target market. However, ASIC says that issuers still need to consider why these distribution conditions and restrictions will make it more likely that the consumers who acquire the product are in the target market, and issuers are encouraged to explain in the TMD why these distribution conditions and restrictions will make it more likely that consumer who acquire the product are in the target market.

What to do now

DDO remains a priority for ASIC, and ASIC will continue to take action to monitor and enforce DDO in for the foreseeable future.

In light of the findings in Report 795, entities that do not take the opportunity now to review current DDO policies and procedures may face enforcement action later.

The shortcomings and best practices identified in Report 795 should be used a guide when assessing the adequacy of current policies and procedures and identifying areas for improvement.

How we can help

We have worked with a number of clients on their DDO implementation and can assist with:

• compliance assurance reviews of your DDO program;

• staff training on DDO; and

• legal advice on DDO issues.

Contact us for a confidential discussion.

Kathleen Harris and Patrick Dwyer
Legal Directors