By Mark Bland, Partner, Geoffrey McCarthy, Special Counsel and Ashley Kasner, Lawyer
This fortnightly update is designed to help superannuation trustees track and manage regulatory change. We look ahead to forthcoming developments, look back at recent changes and then consider the impact on trustees. This edition’s spotlight is on the Design and Distributions Obligations which will have significant ramifications for superannuation fund design and distribution.
- APRA announced revised reporting requirements for its Pandemic Data Collection
- The Government published an issues paper for Review of the Privacy Act 1988
Public hearing of House Standing Economics Committee – Superannuation sector on 6 November. Attending are REI Super, AustralianSuper, BT Super, IFM Investors, Suncorp and Mercer.
Parliament is to sit on 9 – 12 November and 30 November.
Public hearing of Standing Economics Committee – Superannuation sector is be held on 20 November. The program is not yet released
5 October 2021 – Design and Distribution Obligations come into effect.
30 October – Attorney-General publishes an issues paper for Review of the Privacy Act 1988. The review will consider a range of issues including potential extension of the coverage of the Act and how it can appropriately apply in relation to digital identifiers.
28 October – Introduction of a bill including provisions for transition from SCT to AFCA such as ability for the Court to remit SCT decisions to AFCA Treasury Laws Amendment (2020 Measures No. 4) Bill 2020 and referred to Senate Economic Legislation Committtee.
27 October – Senate Estimates sitting heard from ASIC and APRA.
27 October – APRA published FAQs on its multi-year project to upgrade the breadth, depth and quality of its superannuation data collection. By way of these changes APRA is proposing to publish the data to increase accountability and competition.
26 October – Senate Estimates heard from Treasury. Discussion covered superannuation policy. Proof Hansard Discussion on superannuation included early release and the impact on women including financial abuse, the potential saving from and possible issues with the Your Future, Your Super proposals
23 October – At the House of Representatives Economics Committee Hearing in relation to the Annual Reports of ASIC and APRA, the Committee raised issues that indicate potential areas of continuing concern relevant to superannuation, including:
- potentially misleading attempts to connect persons using search facilities with funds;
- whether valuations are producing consistent outcomes;
- union official providing unlicensed financial advice;
- the roles of ASIC and APRA in pursuing underperformance by superannuation funds;
- the potential for Your Future, Your Super underperformance measure to promote index tracking;
- APRA’s proposed guidance about climate risks and other ESG factors in updates to SPG 530; and
- APRA told the Committee that one of its priorities was its superannuation data transformation project
21 October – Treasury published draft amending legislation to enable insurance opt in elections to continue to apply in a successor fund
21 October – Treasury published draft regulations to retrospectively address NZ permanent residents for COVID-19 Early release of super
21 October – APRA announced revised reporting requirements for its Pandemic Data Collection, which broadly require trustees to report on how they are impacted by COVID-19 and the early release scheme via D2A, which would only continue until 31 January 2021. From September and until 31 January 2021, only the data relating to operation resilience in the monthly reports and early release initiative demographics in the quarterly reports needs to be submitted.
16 October – AFCA confirms the concession in timing of responses to complaints does not apply to complaints lodged after 31 October 2020
On the horizon spotlight – Design & Distribution Obligations
- The Design and Distribution obligations (DDO or DD Obligations) will require product issuers to ensure that a wide range of products have a documented target market determination and that it is reviewed as required
- Distributors will have to plan distribution to make sure that financial products end up in the hands of retail members only for whom the products are appropriate in line with the determination
- Issuers and distributors will have to report to ASIC any significant take up outside the target
- The obligations apply from 5 October 2021
- ASIC has consulted on regulatory guidance and is expected to publish it soon
Following a long and winding road, DDO’s inception can be traced back at least to the Financial System Inquiry Final Report from 2014, which identified shortcomings in the disclosure regime and recommended product suitability obligations and a last resort intervention power for ASIC. Following several years of consultations and submissions, the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill was passed in April 2019 and commences on 5 October 2021. ASIC had originally planned to have published its anticipated regulatory guide but this has not occurred and is expected soon.
Design and Distribution Obligations
What financial products do the Design and Distribution Obligations apply to?
The DDO regime applies generally to financial products under the Corporations Act 2001 or the Australian Securities and Investments Commission Act 2001.
Persons subject to the DDO generally include:
- Persons who are required to prepare a product disclosure statement (PDS);
- Persons who are required to prepare a disclosure document pursuant to the ‘Fundraising’ provisions of the Corporations Act; and
- Persons issuing financial products to a retail client that are not financial products under Ch 7 of the Corporations Act such as credit.
MySuper products as well as defined benefit interests and interests in eligible rollover funds are examples of products excluded from the new regime. MySuper products were considered to be adequately governed by the relevant provisions of the SIS Act.
Closed superannuation products that no longer require a PDS will not be caught.
Originally the DD Obligations were to be linked to the disclosure obligations as they were intended to mitigate and address the issues identified in relation to inadequate product disclosure. However, Parliamentary amendments focusing on the appropriateness of the regime for credit products have resulted in a very broad application which is not limited by the provisions determining when disclosure is required under the Corporations Act. Some exemptions apply under the regulations.
Who do the Design and Distribution Obligations apply to?
The DD Obligations apply to:
- issuers of financial products (e.g. trustees of superannuation funds); and
- distributors of financial products (those who provide general advice, deal or provide a PDS)
in relation to the issue and distribution to retail clients (retail product distribution conduct).
What are the new Design and Distribution Obligations?
The DD Obligations are separated into ‘Design’ obligations and ‘Distribution’ obligations.
In essence product issuers must make, publish and review a financial product’s target market determination (TMD).
Distributors on the other hand must take reasonable steps that would result in, or be reasonably likely to result in, retail product distribution conduct being consistent with the TMD and notify the issuer of ‘significant dealings’ that are not consistent.
The obligations do not apply to distribution on the basis of personal advice. The personal advice requirements were considered to provide an alternative protection. It appears this will only apply to Ch 7 financial products.
Trustees will be subject to a requirement to notify ASIC of any significant dealings that are not consistent with a product’s TMD. Distributors who become aware of such dealings must notify the trustee.
Employers who merely give a PDS for a default super fund, arrange payment to the default fund or an employee’s chosen fund or arrange for the issue of a superannuation interest to the employee in the default fund or the employee’s chosen fund are not subject to the requirements: reg 7.8A.25 of the Corporations Regulations 2001 as it will apply under the Corporations Amendment (Design and Distribution Obligations) Regulations 2019.
What is a ‘target market determination’?
The central facet of the DD Obligations is the ‘target market determination’ (TMD). Appropriately defining the ‘target market’ will be fundamental to ensuring that both product issuers and distributors will be able to comply with the DD Obligations. ASIC in Consultation Paper 325 Product design and distribution obligations (CP 325) proposes merely to say that what amounts to an appropriate TMD can differ, depending on the type and particular characteristics of the financial product to be issued, the intended distribution approach and the issuer’s product governance framework.
A TMD will be appropriate in relation to a particular product where it is reasonable to conclude that if the product would be acquired by a retail client:
- it would be likely that the retail client is in the target market; and
- an issue or sale of the product would likely be consistent with the likely objectives, financial situation and needs of the retail client.
In CP 325 ASIC proposes to give guidance that it will also be useful for product issuers to consider the negative target market, being those for whom the product would be clearly unsuitable.
The obligation to determine the target market requires product issuers to carefully consider the potential acquirers of their products. An important consideration is the distinction between determining the target market and the provision of personal advice. Under the amendments, s 776B(3A) will provide that asking for information solely for the purpose of determining whether a client falls within a target market and informing the person of whether they do fall into the target market is not in personal advice. Product issuers who give advice and wish to rely on the exclusion must be conscious of limiting the questions asked of retail clients so it is solely for this purpose to ensure that advice it is not treated as personal advice. Advice given after asking those questions to determine if a client falls within a target market can still be personal advice if the information provided is considered, or a reasonable person would expect it to be considered, in providing the advice (beyond merely informing the person they are in the target market).
The TMD must:
- be in writing;
- describe the class of retail clients comprising the target market;
- specify conditions and restrictions for the distribution of the product;
- identify and outline events or circumstances under which a TMD is no longer appropriate (review triggers);
- specify the ‘review periods’;
- specify the period in which a distributor must notify the issuer of any complaints about the product; and
- specify the information required to determine when a TMD is no longer appropriate.
The TMD must be made prior to the distribution of the relevant product and be publicly available, free of charge.
While ASIC draft guidance indicates it will avoid detailed guidance, the European Securities and Market Authority has issued quite substantive guidance in connection with the corresponding MIFID II product governance requirements regime in the EU which commenced in January 2018. Helpfully, it even provides examples of target market assessments for particular products. While the context and detail of the relevant requirements needs to be considered, perhaps the biggest takeaway is that by way of its examples, the European regulator seems to be suggesting concise and precise TMDs are the way to go. ASIC’s expectations are not clear as yet.
Investment options and insurance in superannuation
In CP 325 ASIC acknowledges that it may be more difficult to prepare a TMD for a superannuation product that contains different investment options or insurance. ASIC proposes to indicate that in practice trustees will need to refer to different target markets for different investment options or groups of investment options in the TMD. The target market will also need to take into account insurance that is available through the product. ASIC considers the obligation is separate from the requirements for a member outcomes assessment but indicates it will discuss further with APRA to seek to promote consistency.
ASIC’s proposed guidance is that the operator of an IDPS platform must make a TMD in relation to the platform itself, as a separate financial product to the products offered or available on its platform. This is likely to include consideration of the costs and features of the platform, as well as the types of products available on the platform.
An issuer of financial products offered or available on the platform must make a TMD in relation to the underlying product. This is likely to include consideration of whether the selected platform is an appropriate distribution channel for the product.
Presumably the same guidance would apply to a platform operated as a registered scheme would also apply to a platform that is a superannuation fund.
If a superannuation trustee relies on ASIC Corporations (Superannuation: Investment Strategies) Instrument 2016/65 which facilitates compliance with the requirements about giving a PDS for financial products available through superannuation platforms, the trustee may also have DD Obligations relating to those products, as well as the issuer of those accessible financial products. This may apply if the trustee seeks to rely on the relief under the modified terms in that instrument, which also means that under the instrument that the requirement to prepare a PDS for those accessible financial products would include the trustee: s 1012IA(5)(aa) – (ac). ASIC might give further guidance on this.
Issuers must take reasonable steps that will, or are reasonably likely to, result in distribution being consistent with the TMD for the financial product. In CP 325 ASIC proposes to give guidance that what is reasonable that will depend on among other things:
- the distribution conditions that are specified in the TMD;
- the issuer’s marketing and promotional materials;
- the selection of distributors;
- the supervision and monitoring of distributors;
- the issuer’s ability to eliminate or appropriately manage conflicts of interest; and
- whether issuers have provided distributors with sufficient information to help them ensure that distribution is consistent with the TMD.
Issuers must review their TMD if circumstances trigger the need to do so as set out in the TMD and report to ASIC is there is significant distribution outside the TMD.
There are complementary obligations on distributors. Distributors must keep records and report to the issuer in accordance with the TMD.
What are the consequences of non-compliance?
Failure to comply with the DD Obligations carries both civil and criminal penalties.
A product issuer or distributor may be subject to regulatory action for non-compliance.
ASIC has information gathering powers in relation to the DD Obligations, specifically to obtain information that the distributor and issuer must maintain under their record-keeping obligations.
ASIC has also been granted stop orders powers in relation to contraventions of the DD Obligations including:
- failure to comply with the TMD obligation;
- engaging in retail product distribution conduct in the absence of a TMD or an appropriate TMD; and
- failure by the distributor to take reasonable steps to ensure their conduct is compliant with the TMD.
The subject of a stop order must not engage in conduct contrary to ASIC’s order and must take reasonable steps to ensure that other people engaged in the conduct are aware of the order.
An important update to the disclosure regime which operates to support the DD Obligations is the amendment to section 1018A of the Corporations Act that mandates that promotional material of financial products must now refer to the PDS, and when a TMD is required, the product’s target market.
Trustees will need to be careful not to engage in misleading or deceptive conduct by making representations that are not supported by the product features.
ASIC has proposed to apply a focus to whether the marketing of product may exploit consumer biases that result in them acquiring financial products that are not suitable.
The Act introduces a new category of obligations in relation to the design, issue and distribution of financial products, including superannuation choice products. Superannuation products are already subject to a disclosure regime for retail offers. The DD Obligations, however, extend the regulatory regime and reinforce the customer-centric approach that trustees and other distributors must adopt. Trustees are able to begin implementing elements of the DD Obligations into their current product issue and distribution framework in anticipation of the October 2021 commencement. As it will be a significant shift in the retail superannuation landscape, it should be a key consideration incorporated into the roadmap of both existing and proposed products starting sooner than later.
The introduction of the DD Obligations is likely to significantly increase the compliance and regulatory burden imposed on trustees. For products caught, trustees must develop and implement policies and procedures to determine the appropriate TMD with reference to the potential acquirers and the suitability of the products. This is likely to require comprehensive market-based and customer-based research.
In addition, distributors will need to ensure an adequate risk management methodology is implemented to ensure that retail product distribution conduct is consistent with the product’s TMD. This will be critical to ensure that products are distributed appropriately and mitigate or minimise any risk to consumers arising from inappropriate distribution.
One of the contentious areas that may be considered in determining a target market is the approach to environmental, social and governance (ESG) considerations in investments and the operation of the fund. This should also be considered in the determining the negative target market. ESG is increasingly a factor that consumers consider in deciding products, either as a positive or negative attribute.
DDO comes into force on 5 October 2021 (as a result of a 6 month deferral by ASIC). To prepare for the new regime, in relation to the issuer obligations, trustees should:
- take proactive steps to understand and determine the relevant target market for each product designed, issued and distributed, via internal, customer and market-based research;
- ensure that there are mechanisms to receive data to establish that clients are within the TMD including what reporting by distributors will be required;
- build TMD findings into new or updated policies and procedures which enable the issuer to consider and review the TMD periodically and on the occurrence of ‘review triggers’;
- review risk management and product monitoring policies and update in relation to DD Obligations processes and responsibilities; and
- update advertising and PDSs to refer to the TMD.
In relation to distribution obligations, trustees (and other distributors) should also:
- prepare to update promotional materials, advertisements and published statements to refer to and be consistent with the product’s TMD;
- build processes to monitor and implement the ceasing of advice and dealing of products whose TMD is under review or inappropriate at any given time; and
- in anticipation of TMDs being made for distributed products, consider which distribution and marketing channels will continue to be appropriate and plan to wind down those that won’t be.
You may also be interested in reading some of our other commentary in our previous editions’ spotlights:
- Your Future, Your Super – RegTracker – 19 October 2020
- Intra-fund advice – RegTracker – 5 October 2020
- Fee and Costs Disclosure – RegTracker – 21 September 2020
- APRA Data Collection Consultation – RegTracker – 7 September 2020
- APRA and ASIC approach to COVID-19 – RegTracker – 21 August 2020
- ASIC’s Internal Dispute Resolution Requirements – RegTracker – 7 August 2020
- Business Performance Review and Outcomes Assessment – RegTracker – 27 July 2020
- AFCA’s approach to Superannuation – RegTracker – 13 July 2020
- ASIC Interim Corporate Plan 2020-2021 – RegTracker – 26 June 2020
- Hawking of superannuation products – RegTracker – 12 June 2020
- New financial service: Acting as superannuation trustee – RegTracker – 29 May 2020
- Strengthening breach reporting – RegTracker – 15 May 2020