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ASIC issued
Report 770 Design and Distribution Obligations: Retail OTC
Derivatives ("Report 770") after
conducting a review of compliance with the design and distribution
obligations ("DDO") by over-the-counter
("OTC") derivative issuers to retail
clients. The findings of Report 770 are relevant and applicable to
all retail product issuers. The OTC derivative sector reviewed
contains over 60 Australian financial services licensees
("AFSLs") that issue complex, high-risk
OTC derivatives to retail clients as well as many more distributors
for these products.
Report 770 builds on previous reports and guidance issued by
ASIC in relation to the DDO such as:
This article summaries the key findings and observations in
Report 770.
Key Findings and Observations in Report 770
ASIC identified three areas that require improvement by product
issuers and distributors:
Making an appropriate Target Market Determination
("TMD");
Distribution consistent with the TMD and reasonable steps;
and
Monitoring and review arrangements.
Report 770 outlines 7 key findings which we have summarised in
the table below including good and bad examples for each
finding.
Finding 1: Use of available data
Examples of good practices observed:
using both qualitative and quantitative data in developing a
TMD;
drawing on data from both internal and external resources such
as market reports or academic research; and
using existing data on a regular basis to exclude consumers for
whom the product would likely be inappropriate, such as analysing
the characteristics of loss-making accounts.
Examples of poor practices observed:
determining the target market by describing the existing
consumer base instead of considering whether the product is
appropriate for these consumers and their likely objectives,
financial situation and needs; and
not using any data in product design or assessing whether the
product would likely be consistent with the objectives, financial
situations and needs for the consumers in the target market.
Finding 2: Insufficient granularity in
TMDs
Examples of good practices observed:
appropriately describing the high-risk nature of derivative
products; and
using available data to identify target market characteristics
such as consumers' trading history, timing and types of trades,
characteristics of loss-making accounts.
Examples of poor practices observed:
not clearly defining the target market;
inappropriate risk profiles being used in the target market -
for example stating that CFDs are high risk products that are not
appropriate for consumers seeking 'medium risk'
investments; and
inappropriate investment timeframes - CFDs are unlikely to be
suitable for consumers seeking longer investment timeframes due to
the volatility, leverage, potential for capital loss etc.
Finding 3: Over-reliance on client
questionnaire
Examples of good practices observed:
use of questionnaires as a final check instead of as the
primary or only method of assessing whether a consumer is within
the target market;
use of 'knock-out' questions to exclude consumers from
the onboarding process when responses provided would indicate that
the consumer is not likely to be within the target market; and
use of lock-out periods to stop consumers from re-attempting
the questionnaire if they were unsuccessful during the first
onboarding process.
Examples of poor practices observed:
using prompts that allow potential consumers to review any
"unacceptable answers" so that consumers who would not
ordinarily fall within the target market are prompted to change
their responses;
allowing excessive attempts to pass the questionnaire; and
asking consumers to self-certify that they are in the target
market. ASIC noted this practice is inconsistent with the
objectives of the DDO regime.
Finding 4: Over-reliance on existing
controls
Examples of good practices observed:
utilising questionnaires that involve a range of questions
targeted to the TMD eligibility criteria;
engaging in a regular, formal and external review of the TMD
and compliance with the DDO; and
having and implementing formal policies covering distribution,
marketing, advertising, product development, and governance.
Examples of poor practices observed:
relying on a 'client qualification' test designed for
RG227 disclosure benchmarks to assess whether a consumer is within
the target market; failure to change arrangements for distribution
of CFDs following the commencement of the DDO. ASIC noted product
issuers should re-consider distribution conditions in line with
their current target market; and
failure to update the TMD following the annual review.
Finding 5: Marketing
practices
Examples of good practices observed:
using existing client data to exclude and restrict the
potential audience base for certain marketing strategies;
using targeted campaigns for specific distribution channels and
publications such as targeting existing experienced users rather
than new 'first time' traders; and
applying the key words and filters to narrow the potential
audience base and exclude certain groups of retail consumers.
Examples of poor practices observed:
engaging in mass marketing advertising campaigns such as
television commercials, sponsorship of sporting teams, advertising
at sporting events and/or billboard advertising;
marketing through 'partner' campaigns; and
marketing through comparison websites and social media which
are accessible to any consumer.
Finding 6: Poorly defined TMD review
triggers
Examples of good practices observed;
conducting client outcome reviews which monitor the frequency,
value and time period of losses when reviewing client outcomes to
determine if the target market might not be appropriate and should
be adjusted; and
having realistic complaint triggers. This means that issuers
may explore triggers that are not only referring to the number of
complaints received but factors such as nature of the complaints
and the percentage increase of the complaints during different
periods.
Examples of poor practices observed:
implementing review triggers that are unrealistic, especially
when the triggers are set too high so there is a low probability of
a review trigger being instigated;
not using all available information but only restricting data
gathered through the onboarding process. It is recommended that
product issuers consider all available data obtained throughout the
lifecycle of the product; and
reactive in responding to review triggers rather than
proactively monitoring and analysing available data.
Finding 7: Leadership engagement
needed
Examples of good practices observed:
Board of product issuers taking a close interest in product
management and consumer outcomes;
incorporating data collection and analysis to generate
quantitative reports for senior management and the Board for
product management purposes; and
having regular formal reviews that involve various departments
across the business and presenting findings to the Board for
review.
Examples of poor practices observed:
having no formal role for Board reviews in the DDO compliance
framework;
the Board does not take a proactive role and limits their
monitoring to receiving compliance updates; and
not considering the appropriateness of new issuance to existing
clients.
Other Insights
Report 770 and ASIC's recent enforcement actions have
triggered product issuers and distributors to review their DDO
framework as well as their TMDs. Sophie Grace has written a
previous article on ASIC's TMD reviews which may also be
helpful to issuers of financial products.
Based on our recent experience, we have further observed
that:
some issuers do not take non-individual retail clients (such as
companies and trusts) into account in their product design and TMD
preparation. In particular, some issuers lack documented records
showing the likely objectives, financial situations and needs for
non-individual retail clients;
some issuers that onboard retail company clients do not require
all persons who are authorised by the company to place trades or
transact on the company's behalf to pass the suitability test
and/or qualification test; and
some issuers have shell companies as retail clients and are
unsure about how the DDO regime and their existing TMD apply to
these clients.
Sophie Grace can assist retail OTC derivative issuers to
navigate their compliance with the DDO regime as well as the
following previous ASIC publications on retail OTC derivatives:
