The Design and Distribution Obligation (DDO) regime, commencing on 5 October 2021, will have a significant impact on financial advisers. Although the DDO regime is primarily aimed at financial product distribution that is not related to personal advice, there will be certain obligations on financial advisers and/or their licensees when they provide personal advice.
Background and purpose
The Financial System Inquiry (FSI) Final Report, published in November 2014, included Recommendation 21:
Introduce a targeted and principles-based product design and distribution obligation1.
A key problem the FSI sought to address was the failure of the financial services industry to match financial products to suitable consumers.
The FSI Final Report stated:
The existing framework relies heavily on disclosure, financial advice and financial literacy. However, disclosure can be ineffective for a number of reasons, including consumer disengagement, complexity of documents and products, behavioural biases, misaligned interests and low financial literacy. Many consumers do not seek advice, and those who do may receive poor-quality advice. Many products are also distributed directly to consumers2.
The stated objectives of the FSI’s proposed regime were to:
- Reduce the number of consumers buying products that do not match their needs, and reduce consequent significant consumer detriment
- Promote fair treatment of consumers by firms that design and distribute financial products
- Promote efficiency and limit or avoid the future need for more prescriptive regulation
- Build confidence and trust in the financial system3.
In October 2015, the Government agreed to implement the recommendation, subject to detailed consultation with stakeholders. The DDO legislation was passed by Parliament in April 2019, originally for commencement on 5 April 2021, but later deferred until 5 October 2021 because of the COVID-19 pandemic.
Related regulations were made in December 2019. ASIC released its finalised regulatory guidance RG 274 on 11 December 2020, after extended consultation with the industry.
How DDO works, in brief
The DDO regime sets obligations for two key parties in the financial services industry: product issuers (Issuers) and product distributors (Distributors). Generally, these obligations arise when certain financial products are ‘distributed’ to retail clients. The obligations are designed to assist consumers in obtaining appropriate financial products by requiring a customer-centric approach to the design, marketing and distribution of financial products.
At the design stage, Issuers must design financial products that are likely to be consistent with the objectives, financial situation and needs of the intended consumers. They are required to make a target market determination (TMD) publicly available.
At the distribution stage, broadly, Issuers and Distributors must take ‘reasonable steps’ that are reasonably likely to ensure that consumers are receiving products suited to their objectives, financial situation and needs. Issuers must monitor consumer outcomes and review their products and TMD to facilitate these outcomes.
GreyStoneFM is a fund manager whose managed fund products are distributed generally by financial advisers to retail clients. GreyStoneFM is an Issuer in the DDO regime. If GreyStoneFM also allows clients to purchase managed funds directly, it would be a Distributor too.
The financial advisers who distribute GreysStoneFM’s managed fund products are Distributors
Which financial products are ‘in-scope’ for DDO purposes?
Generally, those financial products which require disclosure documents under the Corporations Act (for example, a prospectus or product disclose statement (PDS)) are in-scope for DDO purposes, although certain other products are included also (for example, mortgage products).
The following table summarises some of the product inclusions and exclusions for DDO purposes.
|Financial products included||Managed funds|
|Certain superannuation funds|
|Certain exchanged traded products (ETPs) and listed investment companies/trusts|
|Credit contracts and short-term credit facilities|
|Basic banking products|
|Corporate bonds and debentures|
|Investor directed portfolio services (wrap accounts)|
|Specific exclusions:||Margin lending facilities|
|Most ordinary shares|
|Securities held in employee share schemes|
Who is an Issuer?
Generally, Issuers are those in the financial services industry who are responsible for developing financial products and preparing disclosure documents.
Issuers will be required to make a TMD for financial products included in the DDO regime, and take reasonable steps that will, or are reasonably likely to, result in distribution that is consistent with the TMD.
Issuers will also be required to report to ASIC any ‘significant dealings’ they are aware of that are outside of the target market.
They will also be required to regularly review their TMDs for appropriateness, and make adjustments to either their product or TMD based on data received from Distributors and other sources.
There are also certain record keeping requirements.
What’s a TMD, and what’s in it?
The purpose of a target market determination (TMD) is to ensure Issuers design products for which an appropriate target market can be defined, and for which there are distribution channels to that market that are feasible and appropriate. It is intended to help Distributors understand who the product is aimed at.
A TMD must be:
- made by the Issuer in writing
- publicly available
- free of charge.
As a minimum, a TMD must specify:
- the class of retail clients that comprise the target market for the product
- any conditions and restrictions on distribution of the product
- the event and circumstances that would suggest the TMD is no longer appropriate (review triggers)
- the maximum review period for the TMD
- the complaints reporting period
- the information required to determine that the TMD is no longer appropriate, who should provide that information to the Issuer and when it should be provided.
Tip 1: A TMD is a dynamic document that will change over time. Distributors will need a system for keeping up to date with the TMDs of the products they use regularly.
Importantly, although the target market of a product must comprise clients that the product is suited to generally, based on their likely objectives, financial situation and needs, an Issuer is not required to have that knowledge of individual clients.
Also, in a Distributor’s assessment of whether a client is within the target market, enquiries about the client’s objectives, financial situation and needs, or any other information gathered solely for the purposes of assessing whether a client is within the target market, does not mean personal advice is being provided.
What is ‘distribution’?
Distribution for DDO purposes (referred to in the legislation as ‘retail product distribution conduct’) will generally occur when any of the following happen in relation to a retail client:
- dealing in a financial product
- providing a disclosure document (for example, a prospectus or PDS)
- providing financial product advice
Providing personal advice is ‘excluded conduct’, as is distribution that involves implementation of personal advice. Certain DDO exemptions and exclusions apply where excluded conduct occurs – see further discussion below.
Who is a Distributor?
Generally, Distributors are those in the financial services industry who engage with potential investors in a financial product. Distributors potentially include:
- product issuers (eg fund managers, banks, etc) who deal directly with investors
- financial services licensees and/or their authorised representatives
- credit licensees and/or their credit licensee representatives.
Broadly, Distributors must not distribute an in-scope product unless a TMD has been made, or all reasonable enquiries have been made and the Distributor believes a TMD has been made. Similarly, distribution must not occur if an Issuer has informed the Distributor that a TMD is subject to a review trigger (or another event or circumstance that may deem the TMD inappropriate) until a new TMD has been made.
Distributors (like Issuers) must take reasonable steps that will, or are reasonably likely to, result in distribution that is consistent with the TMD.
If a Distributor becomes aware of a significant dealing and is aware that the dealing is not consistent with the TMD, it must report it to the Issuer within 10 business days. Distributors must also report the number of complaints received in relation to an Issuer’s product, as well as any other information the Issuer requires in its TMD, within 10 business days of the end of the reporting period specified in the TMD.
However, some of the Distributor obligations do not apply if the product distribution is limited to personal advice and implementing personal advice.
DDO for personal advice providers
Licensees and their authorised representatives are Distributors for DDO purposes. Distribution conduct in scope for DDO includes providing financial product advice to retail clients, providing retail clients with regulated disclosure documents and dealing in a financial product. Relevantly, for advice licensees, dealing includes arranging for a client to acquire a product. Financial product advice is either general advice or personal advice.
Personal advice is financial product advice where the provider has considered one or more of the person’s objectives, financial situation and needs, or a reasonable person might expect the provider to have considered one or more of those matters. General advice is financial product advice that is not personal advice.
As mentioned above, personal advice and dealing to implement that personal advice, is ‘excluded conduct’. Some of the DDO Distributor obligations do not apply to ‘excluded conduct’.
The policy behind excluding personal advice related distribution from some of the DDO obligations lies in the greater understanding a financial adviser will have of the client’s objectives, financial situation and needs, putting them in a better position to assess the suitability of a financial product to the client’s circumstances than an Issuer can be expected to be.
Nonetheless it is important for financial advisers to understand the different DDO implications when providing personal advice, versus other types of distribution conduct caught by DDO, including providing general advice and/or execution-only services, where the exclusions do not apply.
Personal advice – consider TMD
One of the key exclusions for Distributors in relation to personal advice is the exemption from the reasonable steps obligation (that is, to take reasonable steps that will, or are reasonably likely to, result in distribution that is consistent with the TMD).
However, ASIC states in Regulatory Guide RG 274 that a TMD ‘should be considered by financial advisers in providing (personal) advice and meeting their best interests duty.’4 Note that ASIC does not state that a financial adviser is to assess whether client is within the target market. ASIC states:
It may be appropriate for a financial adviser to advise a consumer outside of the target market to acquire a financial product, when acquisition would be in the best interests of the consumer.5
Tip 2: When providing personal advice regarding a product that has a TMD, financial advisers should read and consider the content of the TMD in relation to their client’s circumstances, as part of meeting their best interests duty obligation.
Personal advice – product application process
To meet their reasonable steps obligation, Issuers may request information from Distributors as part of the financial product application process. Although not strictly required by the legislation, some Issuers may choose to ask Distributors to assess whether a client is within the target market described in the TMD.
It is also open for Issuers to request in their TMD whatever information they consider is needed to meet their DDO obligation to identify promptly whether a review trigger for the TMD has occurred. This could also involve requesting information from personal advice providers regarding whether a client is within the target market.
Tip 3: Issuers may insist on Distributors assessing whether a client is within the target market even if personal advice is provided. From a commercial perspective, Distributors may have to comply if they wish to use that product.
Personal advice – significant dealings reporting
If a Distributor becomes aware of a significant dealing in a financial product, and also becomes aware that the dealing is not consistent with the product’s TMD, the Distributor is required to notify the Issuer as soon as practicable, but in any case within 10 business days.
The term ‘significant’ is not defined in the legislation. The Explanatory Memorandum to the amending bill provides some guidance on whether a dealing is significant:
Generally, this would require a regulated person to inform an issuer of dealings that would be worthy of their attention having regard to the object of the new regime and the issuer’s role as the product’s designer. However, ultimately whether or not a dealing is significant would be a matter to be determined in the circumstances of each case.
Importantly, a Distributor is only required to report a significant dealing if the Distributor is aware the dealing it is not consistent with the TMD.
Personal advice – distribution information reporting and record keeping
Certain ‘distribution information’ must be provided to the Issuer in a timely manner. The timeframes and information required will be specified by the Issuer in the TMD.
As a minimum, if a Distributor engages in distribution in a reporting period, it must report the number of complaints received in the reporting period regarding the financial product, including if no complaints were received.
Issuers may request information they consider necessary to promptly identify review triggers or other events or circumstances that suggest the TMD is no longer appropriate. A Distributor must report that information if a distribution occurs in the reporting period.
In terms of record keeping obligations, a Distributor must keep complete and accurate records of:
- the number of complaints received
- reasonable steps taken to ensure consistency with TMD (not required if all conduct is ‘excluded conduct’)
- information required in the TMD to be reported to the Issuer, and the dates reported.
Tip 4: Financial advisers will need robust reporting mechanisms and record keeping tools to comply with their DDO obligations.
DDO implications for non-personal advice related distribution
Where distribution occurs that is not related to personal advice, for example as a result of general advice and/or execution only services, additional DDO obligations generally apply.
Importantly, the Distributor will need to determine and follow reasonable steps that will likely result in distribution that is consistent with the product’s TMD. As noted earlier, this obligation generally does not apply to personal advice related distribution.
Reasonable steps should take into account certain factors including:
- risk - the likelihood of distribution being inconsistent with the TMD
- harm - the nature and degree of harm that might result if retail clients who are not in the target market acquire the product
- mitigation - ways of eliminating or minimising the likelihood and the harm, and the availability and suitability of those ways.
Also, distribution cannot occur if a TMD is required and has not been made, or if the Issuer has notified the Distributor that the TMD is under review. Again, these obligations do not apply to personal advice related distribution.
Distributor Governance framework
All Distributors are required to have governance arrangements in place to facilitate compliance with their obligations and to demonstrate sufficient control and oversight over their distribution processes.
Tip 5: Financial advice firms must have a robust DDO governance framework in place by 5 October 2021.