ASIC is taking aim at the broad distribution of over-the-counter (OTC) derivatives and other high-risk retail products after a recent targeted review found significant room for improvement in how they meet their design and distribution obligations (DDO).
ASIC Deputy Chair Karen Chester said, ‘ASIC is disappointed that some high-risk retail product issuers have changed little in response to their design and distribution obligations.’
The introduction of DDO, now well into its second year, marked a significant shift to outcomes-based regulation. Ultimately, it requires financial products to be designed and distributed with clear and contemporary consideration of the objectives, financial situation and needs of the consumers and retail investors being targeted.
Over 60 Australian financial services licensees offer complex, high-risk OTC derivatives to retail clients in Australia, such as contracts for difference (CFDs), crypto derivatives and other novel derivative arrangements. ASIC’s review examined the DDO practices of a sample of issuers and follows earlier ASIC reviews in 2017, 2019, 2020 and 2022, which found that most retail clients lose money trading CFDs.
The findings released in Report 770 Design and distribution obligations: Retail OTC derivatives (REP 770), outline how issuers of retail OTC derivatives are meeting DDO and highlights areas for improvement. REP 770 calls for issuers to:
- address their over-reliance on client questionnaires as a primary distribution filter;
- review their mass marketing of OTC derivatives; and
- make greater use of available data to assist the design of derivative products, target market determinations (TMDs) and distribution arrangements.
‘Product issuers should not simply rely on client questionnaires to meet their distribution obligations. These are high risk products which mean a range of controls are likely needed to ensure they get to the right consumers in their ‘niche’ target markets. We know the stakes are high for resulting harms if they end up with consumers outside of their stated target markets.
‘We are also concerned to see mass market advertising of these high-risk financial products. Absent robust distribution controls, such mass advertising is likely to see these products end up in the wrong hands – consumers they are not intended or appropriate for,’ said Ms Chester.
Since March 2023, ASIC has taken regulatory action against five issuers of retail OTC derivative products for breaches of DDO. This has resulted in 10 interim stop orders relating to retail OTC derivatives, with further DDO-related investigations of high-risk product issuers underway. ASIC recently commenced its first design and distribution proceedings in the Federal Court against a CFD issuer (23-204MR) and will continue to take appropriate regulatory action where it sees DDO contraventions and risk of consumer harm.
‘We will not hesitate to take further action, from stop orders through to court proceedings, especially where we see egregious failures. Our recent penalty proceedings against a CFD issuer is our third DDO-related civil penalty proceeding. This follows our previously commenced proceedings against the distributor of an investment product and an issuer of a credit product. We have further stop orders under consideration and several other DDO-related investigations underway, including for high-risk investment products,’ Ms Chester concluded.
The findings of REP 770 build on ASIC’s earlier findings in Report 762 Design and distribution obligations: Investment products. The report also follows ASIC’s extension of its product intervention orders which strengthened retail investor protections by banning binary options and imposing leverage ratio limits and other conditions on the issue and distribution of CFDs (22-082MR and 22-243MR).
For many years, ASIC has taken strong and frequent regulatory action to address consumer harms from offers of OTC derivatives to retail clients, including:
- enforcement actions;
- AFS licence cancellations and suspensions;
- product intervention orders;
- public warnings;
- strengthened financial resource requirements; and
- publications and regulatory guidance.
DDO requires financial product issuers and distributors to ensure products are designed with consumer needs in mind and distributed in a targeted manner. Financial product firms are also required to monitor outcomes and reassess their product governance arrangements over time. A TMD is a mandatory public document (under DDO) that sets out the class of consumers a financial product is likely to be appropriate for (target market) and matters relevant to the product’s distribution and review.
To date, ASIC has undertaken, or is undertaking, risk-based surveillances in relation to buy now pay later, credit cards, derivatives, investment products, small amount credit and superannuation. ASIC has:
- made 82 interim stop orders (9 issuers have subsequently withdrawn 11 products from the market);
- taken regulatory action against five issuers of retail OTC derivative products for breaches of DDO (22-056MR, 23-127MR, 23-141MR, 23-040MR);
- published surveillance findings in relation to small amount credit contracts (22-352MR), superannuation (22-236MR) and managed investment products (23-115MR); and
- commenced civil penalty proceedings for alleged DDO breaches against Firstmac Limited, a distributor of a managed investment scheme (22-361MR), American Express Australia Limited, an issuer of a credit product (22-338MR), and eToro Aus Capital Limited, an issuer of CFDs (23-204MR).
Regulatory Guide 274 Product design and distribution obligations sets out expectations for compliance and ASIC’s approach to administering the obligations.
© Australian Securities and Investments Commission. Reproduced with permission.