While ASIC’s ‘principles-based approach’ to the DDO will be welcomed by the financial services industry, Mr New says the indirect effects of the legislation could place significant burden on product issuers, such as fund managers, and distributors including financial planning groups.

“The DDO will increase the level of involvement a product issuer will need to have in their distribution network, and the amount of due diligence an issuer will need to undertake. It will also increase the costs of product manufacture and distribution.

“One commercial question in relation to the DDO regime is whether such costs will be passed on to consumers.”

The Draft Guidance suggests product issuers will need processes to assess a distributor’s capacity to comply with Target Market Determination distribution conditions, which may involve issuers supervising and monitoring distributors to a degree, to satisfy their DDO obligations.

“ASIC states that arrangements between issuers and distributors are ‘commercial matters that issuers and distributors can determine among themselves’, but we expect the indirect impact to be significant.”

Mr New said the industry could be satisfied with ASIC’s appropriate regulatory response to the draft DDO guidance, though ASIC has some expectations which go ‘above and beyond the black-letter law’.

“For example, ASIC expects issuers to ‘manage the risk’ of a financial product being widely sold to investors who do not have a diversified portfolio: this is possible if a Target Market Determination states the product is only suited for investors who have or want a diversified portfolio. But it’s not explained how this risk-management does not move the issuer into the realm of giving personal advice.”

The DDO regime was enacted under the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 (DDO & PIP Act), which received royal assent on 5 April 2019. Consultation closes 11 March 2020, with the regulatory guide expected to be released during 2020.

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Mark Petrucco

The Royal Commission into misconduct in the Banking, Superannuation and Financial Services Industry has potential to catch AFSL licence holders unawares with tight time frames and a broad mandate beyond the big banks, according to legal experts.

The signed terms of reference suggest any financial services company could be called upon to provide evidence, according to Mark Petrucco, partner, and Jacob Uljans, special counsel at leading independent law firm Hall & Wilcox. “The terms confirmed a broad mandate, which means any AFSL licence holder may be called upon. It’s not just about the major banks.”

They said financial services firms will be under significant time pressures to produce evidence for the commission. “If previous Royal Commissions are anything to go by, any notices to produce evidence will require materials in very short time in some cases just one week.” There are high penalties for failing to produce evidence, and limited recourse for time extensions.

The initial public hearing of the Royal Commission took place on 12 February 2018, with the first substantive hearings slated to commence in early to mid-March 2018.

Mr Petrucco and Mr Uljans offer five key steps for surviving the Royal Commission:

1. Prepare early: “Leaving everything to the last minute is a classic mistake. You don’t want to be scrambling to produce documents and making sense of your demands on the run.”

Aside from time pressure, there is limited scope for confidentiality with evidence, as royal commissions are open and public and there is potential to be in the public spotlight. “Legal professional privilege may offer some protection, but firms need to consider how they will frame privilege claims and prepare early. Claims are unlikely to succeed if assembled on the run. All indications from the initial hearing are that the Commission is working to a tight timetable and won’t be entertaining requests for substantial extensions of time.”

2. Consider getting on the front foot: Preparing and offering information may be better than awaiting a summons. “Firms won’t be penalised for volunteering information. In past Royal Commissions, we have found the focus can quickly shift from conduct to remedial action for those firms which have identified and remedied a problem.

“What is clear from the initial public hearing is that the Commission’s focus will be on what financial services business have done in response to issues that have arisen and whether that response meets community standards and expectations.

“If there are concerns, consider independent advice. But sometimes the best path is volunteering information to the Commission. The Commission has already invited early submissions from a range of financial services businesses, the responses to which are likely to play a big part in determining the Commission’s areas of focus going forward.”

3. Address policies and procedures: If elements of your business need review or updating, now is the time to act. “It’s a good time to address key areas of focus, such as remuneration – for example, incentives and soft dollar commissions. During the initial public hearing, counsel assisting the Commission noted that concerns around incentive-based remuneration and commissions for referring financial products are amongst the key themes that have emerged from submissions received from the public to date.”

They suggest firms look at their complaints register to find common themes, and review processes if they aren’t responding quickly enough. “You need to show you can deal with problems and complaints quickly. Record-keeping and response times need to be fair and reasonable.”

4. Look for conflicts of interest throughout the organisation: Areas which may demand further scrutiny include parts of the business where a head of department has a high achieving team, which may not be meeting best practice, or community standards or expectations.

Superannuation funds analysing conflicts will need to consider their arrangements with suppliers such as insurers and fund managers. “The commissioner will be looking for tension between superannuation and insurance arrangements, and fund manager fee arrangements.”

5. Preparing for costs: While the big banks have been in preparation for the Commission for some time, few in the broader financial services industry will have budgeted for the Commission, according to Mr Petrucco and Mr Uljans. While it’s uncertain how much in the way of costs can be recouped, firms can take some action. “Firms should review their insurance policies – and may notify insurers.

“You need to ensure your policy will respond if you call it up. Financial services firms may also consider business interruption insurance.”

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