Target market determinations and ASIC stop orders

The appropriateness of Design and Distribution Obligations (DDOs) is now a priority for ASIC in regulating the disclosure of information about financial products to protect consumers (ie investors).

In this article, we provide practical advice on how to adopt a consumer-centric approach in preparing Target Market Determinations (TMDs) that provide adequate levels of disclosure to avoid the risk of regulatory action and reputational harm.

What is a target market determination?

A TMD is a mandatory document that must be prepared and made available to consumers before a financial service provider engages in ‘retail product distribution conduct‘.[1] A TMD should set out the class of consumers that a financial product is likely to be appropriate for (the target market), settings relevant to the product’s distribution, and periods and triggers for review of the TMD to ensure its ongoing appropriateness.

On 5 October 2021, new product design and distribution obligations came into force, with the reforms requiring Australian Financial Service Licence (AFSL) holders to design their financial products to meet the needs of consumers and distribute their financial products in a more targeted manner. Specifically, the obligations require financial product issuers to:

1. prepare a TMD that comprises of a target market that reflects the class of consumers whose likely objectives, financial situation, and needs are met by the financial product on offer;
2. take ‘reasonable steps’ that are reasonably likely to result in financial products reaching consumers in the target market that has been defined by the financial product issuer; and
3. monitor consumer outcomes and review financial products to ensure that consumers are receiving financial products likely to be consistent with their objectives, needs, and financial situation.

On 3 May 2023, ASIC released Report 762 Design and distribution obligations: Investment products, which noted that a review of TMDs issued relating to financial products revealed ‘considerable room for improvement‘. In particular, the following aspects of deficient TMDs were highlighted:

1. Definition of the target market: In at least 15 ‘stop orders’ issued by ASIC, the target market was defined too broadly, and as such potentially captured consumers for whom the financial products were inappropriate. ASIC specifically noted that issuers should ensure that target markets are defined unambiguously, and that the use of qualified language, such as indicating that certain types of consumers may ‘potentially’ be included in the target market, should be avoided where possible.
2. Inappropriate risk profiles: Inappropriate risk profiles, such as the assessment of high-risk financial products as appropriate for consumers with medium risk tolerance, were a factor in at least 21 stop orders. ASIC indicated that issuers should take care to ensure that the risk level of financial products is not understated to ensure that the risk tolerance of consumers is not misaligned with the actual risk level of a financial product. As a general rule, issuers should take care to adequately detail the potential loss from investing in a financial product, rather than placing undue emphasis on a financial product’s returns.
3. Inappropriate investment timeframes and/or withdrawal needs: Issuers listed inappropriate time frames and withdrawal needs in TMDs subject to at least 18 stop orders. For example, an issuer stated that a financial product was appropriate for consumers requiring ‘annual’ withdrawal rights in circumstances where a financial product did not have withdrawal rights available before the end of the fixed period of investment. A further example highlighted by ASIC involved circumstances where issuers of very high-risk financial products indicated that consumers with short-term investment timeframes were captured by the target market, despite the general view that an investor should hold higher risk investments for longer periods to allow them to recoup potential losses. The need to adequately differentiate withdrawal rights from the ability to trade on a secondary market to ensure that consumers who require withdrawal rights are fully informed.
4. Inappropriate template usage: ASIC noted that the majority of issuers reviewed relied heavily upon TMD templates, and the inappropriate use of templates was a factor in at least 13 stop orders issued by ASIC. While ASIC noted that such templates may serve as a useful starting point in the preparation of a TMD, it was emphasised that templates ought to be appropriately tailored to adequately reflect the target market and features of the financial product on offer.
5. Inappropriate distribution conditions: In at least 13 stop orders, issuers included either inappropriate, or in some circumstances, no distribution conditions. Failure to include distribution conditions in a TMD constitutes a breach of s994B(8)(a) of the Corporations Act, and it is critical that distribution conditions are not only included in a TMD, but that the distribution conditions are appropriate for the target market. In particular, distribution conditions ought to be tailored for each specific product, rather than reliance on templates for determining conditions that are appropriate for the target market of each financial product.
6. Inappropriate levels of portfolio allocation: In at least 10 stop orders issued by ASIC, issuers included inappropriate portfolio allocations for the designated target markets. By way of example, in one TMD an asset allocation of 75% for a high-risk financial product was amended to 25% on the basis of ASIC’s intervention.

Since the release of Report 762, ASIC has continued to issue stop orders on a regular basis relating to deficient TMDs, including in relation to financial products that were not specifically captured in ASIC’s review, such as life insurance products, pet insurance products, buy-now-pay-later offerings, superannuation offerings, and CFD distribution. ASIC have also written to the Insurance Council of Australia, the Council of Australian Life Insurers, and the Financial Securities Council about a review it has undertaken of over 100 TMDs for general and life insurance products.

ASIC – Key regulatory action in relation to TMDs

ASIC has stated that its enforcement of compliance with DDOs includes surveillance of TMDs, engagement with institutions on the use of the design and distribution reforms for improving consumer outcomes, and enforcement actions to address poor design and distribution of products.[2] Further, ASIC will pursue targeted, risk-based surveillances and take regulatory action through issuing interim or indefinite stop orders and other regulatory actions available to address any deficiencies in DDOs and TMDs.

To date, ASIC has taken administrative action to issue 81 interim or indefinite stop orders[3] where it holds compliance concerns.

Preparing for and attending a stop order hearing is a time consuming and costly exercise for product issuers, and the issuing of an indefinite or interim stop order is unlikely to be reversed until such time as ASIC is satisfied that compliance with DDOs has been achieved. It follows that product issuers subject to the DDOs should ensure that only compliant TMDs are provided to consumers.

Of particular note are recent stop orders issued in relation to superannuation, buy-now-pay-later products, and insurance products. In its various comments arising from the stop orders it has issued to date, ASIC has identified the following shortcomings in TMDs:

1. the target returns for investment options have been too low to be consistent with investors in the target market, being those seeking high returns;
2. there was a mismatch between investment risk profiles and the return profile identified within the target market;
3. there was not sufficient consideration of investment risk features associated with the investment options;
4. a failure to appropriately define the target market, with the TMD only excluding a narrow subset of consumers who may experience financial difficulties;
5. a failure to specify details about features of a product, or the financial situation of those who would likely use the product;
6. a failure to disclose appropriate distribution conditions to ensure that the product was directed towards the target market;
7. a failure to specify review triggers to monitor consumer outcomes, specifically in relation to missed payments;
8. a failure to consider the impact of key eligibility criteria, such as age and employment criteria, on the suitability of a product; and
9. a failure to specify meaningful distribution conditions to ensure the product was appropriately targeted and excluded consumers in the negative target market.

In addition to the significant stop orders issued by ASIC, we note that ASIC has also commenced civil penalty proceedings where appropriate for alleged breaches of the design and distribution obligations. The first proceedings are against the product issuer of a credit product, alleging that the TMD did not limit distribution and that the product issuer knew customers were likely confused about whether they had applied for a credit card. The second proceedings are against a managed investment scheme distributer, with ASIC alleging that financial products were inappropriately offered to term deposit holders, despite these consumers being outside the target market.

Practical Considerations

Given the proactive regulatory response from ASIC in the above cases, it is imperative that a TMD:

• reflects the PDS and is consistently reviewed and updated to reflect changes as they are made;
• adequately and appropriately defines the target market, ensuring the target market reflects the risk; and
• has review triggers that are appropriately set out to avoid a ‘set-and-forget’ mindset.

If your organisation has not considered its TMDs since the introduction of the DDOs, it is highly recommended that you do so, given ASIC’s recent focus.

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Authored by:

Daniel Maroske, Partner
Matthew Bode, Partner
Anna Fanelli, Senior Associate

[1] Australian Securities & Investments Commission, RG 274 Product design and distribution obligations (Regulatory Guidance No 274, 11 December 2020) 274.29-274.31.

[2] Australian Securities & Investments Commission, ASIC Corporate Plan 2022-26 (Report No ISSN 2205-5908, August 2022) p 10.

[3] Gadens has prepared a consolidated list of each of these Stop Orders, available upon request.