30 March 2021
Distributor selection and monitoring is a vital part of achieving meaningful compliance with the Design and Distribution Obligations. In this post we shine a light on what this means for firms.
We all know how we got here. And why. The 2014 Financial System Inquiry found that the current regime for financial products was inadequate for consumer protection because it relied too heavily on disclosure, general advice and financial literacy. In response, the government introduced the Design and Distribution Obligations (DDO) and Product Intervention Powers (PIP) in 2017. More than ‘a few’ banking and financial advice scandals and a Royal Commission later, DDO and PIP legislation were passed in April 2019 with PIP coming into effect immediately. The extended deadline for DDO is looming with the industry working frantically to achieve compliance by 5 October 2021. ASIC has publicly stated that it expects meaningful compliance from day one.
From our observations, the industry is laser focussed on documenting target market determinations (TMD). And understandably so. Product issuers must make TMDs public, providing a visible sign of compliance with one aspect of DDO.
But let’s be clear – it is only one aspect. DDO is much more than a TMD.
The disclosure trap
The current focus on TMDs is understandable. Firstly, one has to start somewhere. And starting by defining the target market for each product is a good place to begin work. Secondly, the mandatory content in the TMD will tease out thinking in a number of other areas such as distribution conditions and review triggers. Thirdly, not having a TMD means the product cannot be sold and non-compliance will be visible to the market. Lastly, and this is the one to watch out for, writing a document is in our collective comfort zone. The financial services industry has been seeking to achieve compliance through disclosure for years. The machinery in firms for putting a public-facing document in place is well oiled. (ICYMI: ASIC’s research has shown that disclosure and warnings can be ineffective in influencing consumer behaviour and in some instances can contribute to consumer harm.)
However, the TMD is not a disclosure document. Albeit mandatory, it is just one of the documented outputs of the internal interrogation of product design and distribution through the lens of achieving sound consumer outcomes. The TMD is the visible tip of the iceberg under which must lie robust and documented internal processes, systems and controls that come together to achieve compliance with DDO.
Know your distributors
At first, this seems so obvious that it doesn’t need to be said. But across the financial services and credit industry in Australia, the extent to which financial product issuers and credit providers seek to know their distributors varies. As does the power / influence dynamic. In our view, this aspect of DDO compliance could prove to be the most challenging because, in many cases, it represents a step change in the relationship. Plans for data gathering and oversight should be an early part of DDO planning. We recommend that product issuers start engagement with distributors now rather than further down their implementation plans.
What do we mean by “know your distributors” (KYD) and how this is part of DDO? ASIC has been clear that DDO is a principles-based regime that is focussed on having appropriate arrangements (governance, systems, controls) in place to ensure product design and distribution leads to sound consumer outcomes. ASIC has also been clear that the selection and monitoring of distributors forms part of a product issuers reasonable steps obligations. In RG274 ASIC provides that:
“[w]e will consider the steps that an issuer has taken in conducting due diligence in the selection of distribution channels, methods and distributors. Reasonable steps will generally include making an assessment of the capacity of the distributor to comply with the distribution conditions imposed and meet its own obligations as a distributor. We consider that relevant factors would include an assessment of the distributor’s resources, internal controls, past conduct, experience with the target market and competence to distribute the financial product to the target market.”
What does it mean to assess the distributor’s internal controls? A useful reference point, especially for product issuers that also self-distribute, is to consider what processes and controls they have in place internally to ensure the product is sold as intended and then assess whether the distributor has similar controls in place. This could include controls and processes in relation to product, sales and compliance training, scripts / conversation guides, setting of key performance indicators (KPIs) and appropriate use of incentives. Global firms can also learn from their overseas counterparts who may have implemented KYD and distributor oversight programs for the rollout of MiFID II in Europe or the SFC’s product governance requirements in Hong Kong.
In some segments of the industry, this will be a paradigm shift especially where the product issuer / distributor relationship is one where distributors are seen less as business partners and more as valued clients. In these segments there may be a tension as product issuers look to achieve their reasonable steps obligations without ‘troubling’ distributors.
Get the conversation started now
Our strong advice for product issuers and distributors is to get the conversation on information sharing / reporting (e.g. complaints) and distributor oversight started now. Don’t wait until the TMD template is finalised – product issuers should engage with distribution partners and work through the real life practical scenarios and use cases around information sharing. This ensures that the end solution not only achieves compliance for both parties, but ensures that compliance supports end-consumer outcomes. Technology will have to play a key role in providing a lower risk, less manual and more cost effective outcome for issuers and distributors alike.
Six months to go. Watch out for the iceberg.
Update 16 September 2021:
PX Partners has launched a solution that benefits product issuers and distributors by reducing the time, cost and pain often associated with distributor monitoring and due diligence. Go to KYD’s website to learn more and ask for a demo. In the meantime, you can follow us on our LinkedIn.
firstname.lastname@example.org has extensive experience supporting firms in Australia and overseas with distribution oversight and is happy to share her experience.