Advice businesses will feel the effects of proposed new product design, distribution and intervention laws that were introduced to Parliament in Draft form in December 2017. In imac legal’s view, independent and non-aligned advice businesses will feel the biggest effects if these laws go ahead as planned.
Maybe people have been distracted by the Financial Services Royal Commission but it has surprised us that very little attention has been paid to the proposed new product design, distribution and intervention laws as the consequences are far-reaching. Submissions for feedback on the legislation closed on 9 February 2018.
Recommendations to introduce product design and distribution powers as well as product intervention powers came out of the root and branch review of the financial system conducted by the Financial System Inquiry (‘FSI’, ‘the Murray Inquiry’). The Murray Enquiry recommended introducing laws to make product issuers more accountable. The Explanatory Memorandum to the proposed legislation says that:
“the existing regulatory framework governing financial product 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 bias is, 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 consumers. Such issues contributed to consumer detriment from financial investment failures such as Storm Financial, Opes Prime, Westpoint, agribusiness schemes and unlisted debentures, which affected more than 80,000 consumers. Losses from these failures totalled more than $5 billion or $4 billion after compensation and liquidator recoveries. Although these losses have a number of contributing causes, poor product design and distribution practices that disregarded consumer behavioural biases and information imbalances played a significant role.”
So, the rationale for introducing new laws that set new and higher standards for product issuers is understandable and to be commended. However, the way the proposed laws have been drafted means their impact will be much greater than on the product issuers themselves. Indeed, financial advice businesses, particularly those that are not aligned to product manufacturers, will feel the effects of the new laws both directly and indirectly.
Let’s have a look at some of the new requirements
In this article, we will focus mainly on the obligations that affect financial advice businesses. But first, a brief explanation of the ambit of the proposed new rules.
The proposed design and distribution laws generally apply to a financial product if it requires disclosure in a PDS or is a security offered under Chapter 6D of the Corporations Act. There are some exceptions (such as MySuper products, margin lending facilities and small scale securities offerings), but we won’t go into these here.
The product design rules generally apply to issuers of financial products. The distribution rules apply to both issuers and distributors of financial products. It is as “distributors” where financial advisers will face additional obligations.
New product intervention powers will allow ASIC to intervene in the distribution of a financial product and credit product where it perceives a risk of significant consumer detriment.
The Product Design Obligations
In a nutshell, a financial product issuer will be required to:
- Make a target market determination in relation to any financial product caught by the regime (such determinations will need to consider the features of both the product and consumers in those markets as well as appropriate distribution channels. A determination may also include any conditions and restrictions on dealing in, or providing financial advice in relation to, the product);
- review the target market determination as required to ensure it remains appropriate;
- keep records of its decisions in relation to the new regime; and
- notify ASIC of any significant dealings in a product that are not consistent with the product’s target market determination.
Distributors will have five main obligations:
- Not to deal, or provide financial product advice, in relation to a product unless a target market determination has been made;
- not to deal, or provide financial product advice, where a target market determination may longer be appropriate;
- to take reasonable steps to ensure that products are distributed in accordance with the target market determination;
- to collect information related to the distribution of a product; and
- to notify the issuer of a product of any significant dealings in the product that are not consistent with the target market determination.
Financial advice licensees will feel the effects of the new laws in a number of ways, with financial advice businesses not aligned to product issuers to be most affected. The main sources of additional obligations are:
- Through additional obligations in the laws;
- Through additional reporting obligations to product issuers;
- Through additional liabilities for not complying with the new obligations;
- Through the additional compliance measures (and associated expenses) advice licensees will have to implement to comply;
- Through product issuers risk-shifting to the advice licensees.
a) Additional obligations in the laws
The distribution obligations apply to those people that engage with a potential investor in relation to a product. These rules catch more than just product issuers who also distribute their own products and can include advice licensees and their advisers.
Thankfully, while it is not clear what level of detail will be in a target market determination and how prescriptive they will be, distributors are able to rely on the validity of a determination made by an issuer.
Distributors will need to:
- Take reasonable steps to ensure that they distribute a product in accordance with its target market determination;
- collect, and keep records of, distribution information. This will include information about:
- the number, and dollar value, of issues of the product made by the distributor;
- the proportion of those issues that were consistent with the product’s target market determination;
- the ways in which the distributor’s dealings in, or provision of advice in relation to, the product occurred;
- the steps you took to ensure compliance with the target market determination;
- notify ASIC if you become aware that a financial product has been distributed or advised on if that product does not have a target market determination;
- notify the issuer of significant dealings in a product that are not consistent with the target market determination;
- take reasonable steps not to distribute or advise on a product where a target market determination is withdrawn or there is some product intervention action;
- ensure that any promotional material that mentions a particular financial product also includes prescribed target market information.
b) Additional reporting to product issuers
As mentioned above, distributors will need to notify issuers of any significant dealings in a product that are not consistent with the target market determination. Also, as canvassed below, we anticipate that issuers will require evidence of the policies and procedures you have to comply with the obligations as well as access to client files on demand and other evidence they deem necessary.
c) Additional liabilities
The proposed laws contain numerous penalty provisions that affect distributors, including advice groups.
You may face civil or criminal penalties (civil penalties are up to $200,000 for an individual and $1M for a company. Criminal penalties can be up to 5 years imprisonment). Civil penalties can apply if you fail to meet an obligation under the new laws and/or if a person suffers loss because of a contravention.
d) Additional compliance measures
Product research and investment committees will need to have formal rules that identify whether relevant products have a target market determination. Licensees should turn their mind to whether a target market determination is appropriate. Procedures will also be required to ensure that any updates in relation to a determination are received, recorded and, where necessary, quickly actioned. Due diligence procedures will also need to identify if a product has been subject to any product intervention actions.
Advice review monitoring will need to include consideration of target market determinations in order to identify whether particular clients come within the target market. Regulated persons (this can include both licensees and representatives) will need to take reasonable steps to ensure that their dealings in or advice about a particular product are consistent with the most recent determination. Depending on how prescriptive a target market determination is, advice licensees may need to make subjective decisions as to whether particular clients meet the criteria or not. This will not come without risk. Get it wrong and you will have breached the target market determination.
Compliance teams will need procedures to ensure that no advice or dealing is undertaken in relation to any products that are subject to an ASIC stop order or other product intervention. Note: it is not clear as yet whether advisers will be able to advise clients to get out of affected products without falling foul of the requirements not to deal in or advice on a product subject to ASIC action.
Reporting procedures will need to be implemented so that, where necessary, product issuers and/or ASIC are informed if and when a contravention of the distribution obligations occurs. Breach reporting procedures may need to be updated.
e) Product issuers risk – shifting to advice licensees
Where a product issuer is not also the distributor, we anticipate (based on our many years’ experience dealing with issuers) that issuers will amend their distribution terms and conditions to, among other things:
- include a contractual obligation for distributors to notify the issuer of any significant dealings that are not consistent with the target market determination of a product. Some may even require regular attestations or certification that there have been no inconsistent dealings;
- require periodic access to clients’ full advice files in order to determine for itself whether it thinks the clients have met the necessary target market criteria. Naturally, many advice businesses would be reluctant to provide much personal information to product issuers beyond that which is required on application forms;
- require written policies and procedures to be in place to ensure that the new requirements are complied with. We anticipate that issuers may also require evidence of those policies and procedures as well as records of their maintenance and monitoring. Some are likely to prescribe certain requirements for the policies and procedures;
- require indemnity where the issuer attracts liability as a result of the distributor’s actions, even if inadvertent.
While all ‘distributors’ of financial products will be affected, in our view IFAs and non-aligned licensees will be hardest hit. Whereas aligned advice groups will more easily be able to align their procedures to the manufacturer’s requirements and can transfer responsibilities and liabilities between themselves, IFAs do not have the same luxury.
Also, we anticipate product issuers will have different requirements, making it very difficult for advice businesses to develop procedures that will meet the requirements of all issuers.
In summary, we think these laws, while serving a worthwhile purpose, will also put a large impost on advice businesses. While the laws have only been introduced in draft form and there may be changes before they are implemented, imac legal understands there is broad support across Parliament for the thrust of the laws. We will be watching developments carefully.
The relevant Bill is: Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017. If you would like further information about these proposed laws or any other financial services matter, please contact imac legal & compliance at [email protected]