ASIC's design and distribution obligations: lessons and guidance for issuers of investment products

In brief - In the first article in our three-part series examining ASIC's calls on investment product issuers to ‘lift their game’ on design and distribution obligations, we analyse ASIC's recent surveillance and stop orders.

An analysis of ASIC's recent surveillance and stop orders 

The Australian Securities and Investments Commission's (ASIC) financial product design and distribution obligations (DDO) came into force on 5 October 2021. The reforms are targeted at the miss-selling of financial products to retail clients and are aimed at providing consumers with appropriate financial products by requiring issuers and distributors to adopt a consumer-centric approach to the design and distribution of products.

Under section 994 of the Corporations Act, the reforms require financial services providers to:

• design financial products to meet the needs of consumers
• to distribute their products in a targeted manner.

In particular, these obligations require:

• issuers to prepare a target market determination (TMD), comprising a target market reflecting a class of consumers whose likely objectives, financial situation and needs are met by the product
• issuers and distributors to take ‘reasonable steps’ that are reasonably likely to result in financial products reaching consumers in the target market defined by the issuer, and
• issuers to monitor consumer outcomes and review products to ensure that consumers are receiving products that are likely to be consistent with their likely objectives, financial situation and needs.

Stop orders and product intervention powers

The design and distribution obligations are complemented by a product intervention power under which ASIC:

• may make a range of orders prohibiting specified conduct in relation to regulated financial products 
• may proactively reduce the risk of consumers suffering significant detriment from financial and credit products
• must satisfy consultation and notification obligations before an intervention order is made.

ASIC can make two types of product intervention orders:

• an individual order that applies to a specific person(s) in relation to a product; or
• a market-wide order that is applicable to a person in relation to a class of products.

ASIC surveillance 

ASIC issued its first interim stop order in July 2022 and over the following months ASIC has initiated extensive targeted surveillance to check whether product issuers and distributors are complying with DDO. 

Up to June 2023 ASIC has issued 41 interim stop orders under DDO. Of the 41 interim stop orders issued, 33 have been lifted following actions taken by the entities to address ASIC’s concerns or where the products were withdrawn, and * remain in place. 

ASIC has issued the vast majority of interim stop orders for breaches of the TMD requirements by issuers of investment products such as interests in managed investment schemes, shares issued by an investment company, preference shares and debentures. 

To date the surveillance has concentrated on 'small amount' credit, buy now pay later, credit cards, superannuation, derivatives and with a particular focus on the investment product sector including managed investment schemes.

In May 2023, ASIC issued Report 762 Design and distribution obligations: Investment Products which summarises ASIC's key observations on how issuers of investment products are meeting these obligations and which highlights areas for improvement.

In particular, ASIC has examined the approach taken by issuers to product design, including the process issuers have undertaken to prepare a TMD.

ASIC concerned consumers are 'exposed to high-risk products'

ASIC Report 762 focuses on investment products and in this regard ASIC has expressed its concerns that consumers risked being inappropriately exposed to high-risk products.

In the table below we have summarised Report 762 findings on the nature of the default which gave rise to an interim stop order, the regulatory concern and the remediation response.

Default	No. of [Interim] stop orders	Regulatory issue/remediation response
Defining a target market too broadly	15	Issue: Product generated no to very little income  Remedy: Issuer amended TMD to exclude consumers seeking income
Inappropriate risk profile	21	Issue: high-risk product directed at consumers with a medium risk tolerance Remedy: Issuer amended TMD to exclude consumers with a medium risk tolerance
Inappropriate levels of portfolio allocation	10	Issue: Issuer recommended an investible asset allocation of up to 75% for a single, high-risk product  Remedy: Issuer amended the asset allocation down to 25%
Inappropriate intended investment timeframe and/or withdrawal	18	Issue: Issuer stated consumers required ‘annual or longer’ withdrawal rights however there were no withdrawal rights before the end of fixed term Remedy: issuer amended TMD so consumers who needed right to withdraw money before the end of fixed term were classified as outside the target market
Inappropriate or no distribution conditions	13	Issue: Issuer with a very narrow target market did not include any distribution conditions Remedy: Issuer included distribution conditions
Inappropriate use of a TMD template	13	Issue: issuer relied on pre-set asset allocation in a template of up to 25% for a single asset. Remedy: Issuer proposed to adjust asset allocation to 5% before ultimately withdrawing the product

ASIC noted the following regulatory outcomes as a result of the above deficiencies detected:

Regulatory outcome	No. of issuers	No. of products / TMDs
Amendment of TMD content	12	18 TMDs
Withdrawal of TMD	5	7 TMDs withdrawn
Withdrawal of product from the market	9	11 products withdrawn

The second article in our three-part series will take a closer look at the characteristics of investment products which have been targeted under DDO, the regulatory defects and ASIC recommendations to providers and distributors of investment products on areas for improvement.