The design and distribution obligations (DDO) are due to take effect for product issuers and distributors on 5 April, 2021, and there is much to be done in a little over a year if it is to be trouble-free.
The Australian Securities and Investment Commission’s (ASIC’s) consultation paper CP 325 says the introduction of DDO “recognises that…disclosure to consumers…often does not correlate with good consumer outcomes”, so product issuers will be explicitly required to design and issue products that deliver good outcomes for an identified target market of retail consumers. Simply relying on disclosure is no longer enough; clients must be put at the heart of product design and ongoing product governance.
Distributors will not be permitted to make financial products available to retail consumers unless there is a valid target market determination (TMD) in force. That TMD must describe the nature and complexity of the product and what it aims to deliver, as well as the characteristics, objectives and needs of the retail consumers for whom it has been designed. It must list any restrictions on distribution, the latest date by which the issuer must review the TMD and list any events or circumstances that could indicate the
TMD is no longer valid, triggering an earlier review.
One bizarre aspect of the DDO is that, while it is about putting the consumer first in product design and the TMD must be made available to the public free of charge to “[enable] consumers to access a target market determination should they wish to do so”, ASIC does “not consider the target market determination to be a consumer-facing disclosure document”.
Consider this in terms of an investment platform that makes products available for retail consumers to select for their portfolios. On the one hand, the product issuer and the platform each need to issue a TMD – for the fund and the platform, respectively – but, on the other hand, neither needs to consider the TMD to be a consumer-facing document. This sits a bit uncomfortably with “the consumer-centric approach issuers and distributors should take to deliver good consumer outcomes.”
THE VIEW FROM EUROPE
We don’t pretend to know better in Europe, but we have been grappling for years with MiFID II, a European directive that includes the need to determine the appropriate target market for a product and which came into force two years ago.
There are some key differences – under MiFID II, the obligation to ensure products are only sold to the correct target market falls on the distributor, there is no need to produce a document outlining the target market and product issuers don’t need to state the next product review date in advance – but there are enough similarities with DDO to use the MiFID II experience to streamline some of the work required.
One section of the European MiFID Template (or ‘EMT’, used by issuers to send standardised data to distributors) that has taken some getting used to is whether the starting point for the target market assessment is the product or the investor. In other words, is an equity income fund intended to be bought only by investors seeking an income or, from the client’s standpoint, could it be deemed a suitable investment for growth investors who don’t need income?
A more pertinent example may be to ask whether it would always be wrong to include an emerging markets equity fund as a small weighting in a diversified portfolio for a low-medium risk investor. With the objectives and needs of the client at the heart of the product governance process, whether the product could be suitable for such an investor must be the starting point. The difficulty, of course, is how the product issuer can determine suitability for the client without knowing who they are or what other investments they hold.
The EMT has overcome this is by defining the target market through a number of client characteristics, including their needs (growth, income, capital preservation, etc) and issuers answer ‘Y’ (product is designed for them), ‘Neutral’ (not the primary target market, but may be suitable) or ‘N’ (unlikely to be suitable in any circumstance, i.e. the “negative target market”). Any sales into the negative target market must be reported by the distributor to the issuer, who should incorporate that, as appropriate, into their product governance process.
The investment product industry in Europe has tried, as far as practical, to make the client the starting point for the target market assessment and spent a long time agreeing a standardised format for the data to describe it. If there is one thing anyone coming to terms with DDO can take away from MiFID II, that should be it.
If you want to go one step further and show you are really putting the consumer first, go beyond ASIC’s requirement and make the TMD a consumer-friendly document, so the end investor can refer to it and easily understand it when a distributor recommends a product for them.
Mikkel Bates is the regulatory manager for FE fundinfo, the company which owns Money Management.