The Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 passed Parliament last week and received royal assent shortly after. It introduces design and distribution obligations into the Corporations Act 2001 (Cth), requiring financial services entities to consider the design of their retail financial products and the way they are distributed. The amendments to the Corporations Act 2001 (Cth) also give the Australian Securities and Investments Commission (ASIC) power to intervene in situations where there may be significant consumer detriment. The reforms were first proposed in 2014 by the Financial System Inquiry as a way to address the perceived ineffectiveness of giving lengthy disclosure documents to retail clients, and closely mirrored regulatory reform introduced in the United Kingdom in 2013.
The first draft of the legislation was first read in Parliament in September 2018 and initially applied to retail financial products requiring disclosure under the Corporations Act 2001 (Cth). We wrote about the proposed reforms in the Australian Insurance Law Bulletin (see vol 33 no 10). Following the release of the Royal Commission’s Final Report, the legislation was expanded to:
- cover financial products regulated under the Australian Securities and Investments Commission Act 2001 (Cth) – this has the effect of extending the obligations to credit products and warranty products, by way of example;
- include a private cause of action where an entity fails to make a target market determination; and
- give ASIC standing to seek compensation on behalf of affected consumers who are not parties to the legal proceedings.
What are design and distribution obligations?
The design and distribution obligations will take effect from 5 April 2021. From this date, financial products can only be distributed to retail clients if the product issuer, who is also responsible for preparing the product disclosure statement, has made a target market determination under section 994B. Section 994B(3) lists some exemptions from this general requirement and also enables further exemptions to be specified by regulation.
A target market determination is a written document which sets out the information in section 994B(5) and needs to be made available to the public free of charge. In summary, each target market determination must specify for a particular product:
- the class of retail clients comprising the target market;
- conditions on retail product distribution conduct such as restricting it to certain types of distribution. This could mean, for example, requiring certain products to be sold under a personal rather than general advice model;
- review triggers which would reasonably suggest the determination is no longer appropriate. This could mean, for example, when the age and value of a product insured renders the insurance disproportionately expensive;
- the timeframes for periodic review of the determinations;
- the reporting period for reporting information about complaints under section 994F; and
- the kinds of information to identify promptly whether a review trigger has occurred or if the determination is no longer appropriate.
The objective of the target market determination is to ensure that when the product is sold to retail clients, the retail client would likely be in the target market and the product would be consistent with the retail client’s likely objectives, financial situation and needs. Under section 994E, the person who makes the target market determination must take reasonable steps to ensure the retail product distribution conduct is consistent with the determination. This will undoubtedly add compliance costs for the product issuer who needs to oversee distribution by intermediaries, and significantly blurs the traditional distinction between the legal obligations of product issuers and distributors, even where both separately hold AFS licences.
What are the product intervention powers?
The product intervention power commenced on 6 April 2019. Under section 1023D, ASIC may make a product intervention order if it is satisfied a financial product being sold to retail clients has resulted in or is likely to result in significant detriment to retail clients. The order may state that a specified person cannot engage in certain conduct, such as issuing, either entirely or in accordance with the conditions specified in the order. This can apply to a financial product or a class of financial products.
In considering whether a financial product has resulted in or is likely to result in significant detriment to retail clients, section 1023E requires ASIC to consider, among other things, the:
- nature and extent of the detriment;
- actual or potential financial loss to retail clients;
- impact of the detriment on retail clients; and
- matters prescribed by regulation.
ASIC is required to consult with persons likely to be affected by the order, and in the case of APRA regulated entities such as insurers, with APRA before making a product intervention order. Once issued, ASIC will publish the intervention order on its website.
Over the last few years, ASIC has made a number of statements that add-on insurance is an area where the use of product intervention powers is needed. It remains to be seen whether ASIC will target that area now that it has the product intervention power in its regulatory ‘toolkit’.
What should insurers do?
Although ASIC’s product intervention power is already in force, the design and distribution obligations will only apply from 5 April 2021. ASIC has not yet released regulatory guidance on the new provisions.
During the transition period, insurers should undertake a review of affected retail products and distribution channels, and prepare target market determinations ahead of time. These will inform what changes will need to be made to products and their distribution methods. Prompt action should be taken where the review identifies a retail product which may result in significant consumer detriment. Sales practices, incentive arrangements (ie, front line commissions) and third party distribution arrangements are all likely to be impacted by the changes. Close attention needs to be given to the full product lifecycle and distribution arrangements to enable compliance with these obligations. Insurers should also consider how they will comply with the new record-keeping and reporting obligations.
We are currently assisting clients with understanding their obligations under the new laws and can also share with you our experience with analogous regulatory reforms in the UK. Please feel free to contact the authors with any queries or comments.