The start of the Design and Distribution Obligation is still two weeks away but the new regulatory regime has already claimed its first victim.
Managed investment scheme Third Link Growth Fund has announced that it will close to new investments on October 1, although it will continue to operate.
Under DDO, which starts on October 5, financial services companies will be required to identify the target market for their product and design the product for that market. They will have to select appropriate distribution channels and periodically review those arrangements to ensure they continue to be appropriate.
The scheme is aimed at reducing the harm of mis-selling.
The manager of Third Link Growth Fund, Chris Cuffe, wrote in Firstlinks on Sunday that the additional compliance burden of DDO would make it unviable to take any new money.
Cuffe, who is also the chair of Australian Philanthropic Services, started the fund in 2008 with the purpose of donating all its investment management fees to charity. Its service providers work pro bono.
Cuffe had always planned to close the fund to new investment when it hit A$200 million in assets under management and it is close to that mark. In his article he conceded that the start of DDO was not the only reason for closing the fund to new investment.
He wrote: “While we broadly welcome regulation that makes investing easier and more transparent for consumers, Third Link Growth Fund is designed to run as leanly as possible to maximise donations to charity. The DDO compliance burden will increase our costs and decrease the amount we can donate to charity.”
The DDO rules specify that a “target market determination” must describe the class of retail clients that comprise the target market for the product, specify any conditions or restrictions on sale, specify events and circumstances that would suggest that the determination is no longer appropriate, and specify review periods”.
A product cannot be distributed until a target market determination has been made. Distributors of financial products will be required to take reasonable steps to ensure that products are distributed in accordance with the identified target markets.
The law gives ASIC power to enforce the new arrangements, including stop orders and exemption powers.
An extensive list of banking and investment products will be covered. The meaning of a financial product for DDO purposes includes:
• any product that requires a product disclosure statement;
• securities for which a disclosure document must be prepared, such as hybrids;
• credit contracts regulated under the National Consumer Credit Protection Act, including credit cards and home loans;
• short-term credit contracts not covered by the NCCP Act;
• debentures, depository interests in simple corporate bonds;
• basic banking products as defined in the Corporations Act;
• exchange traded products and investor directed portfolio services; and
• certain custodial arrangements.
Last month, Treasury issued a notice, saying it proposes to make changes before the regime starts. They include:
• clarifying that margin lending to corporates is exempt from DDO obligations, consistent with the intention that all margin lending is to be exempt from DDO;
• clarifying that employees of licensees are not subject to their own separate set of DDO obligations;
• ensuring that a 31-day term deposit falls within the DDO regime;
• providing consistency in the application of retail and wholesale investor definitions across the Corporations Act by ensuring it extends to the DDO regime;
• exempting foreign cash settled immediately from the DDO; and
• exempting non-cash payment facilities from the DDO, except for certain facilities, specifically credit and debit card facilities and stored value facilities.
Treasury said the changes were made after industry consultation. To provide certainty as to DDO requirements in the period prior to the Government making these amendments, ASIC will make interim changes consistent with the Government intentions, using its modification and exemption powers under the Corporations Act.
Elstree Investment Management has said the marketing of hybrid securities may have to change completely. ASIC has had concerns about hybrids in the past, seeing them as complex products that are not well understood by the majority of retail investors who buy them.
Elstree said: “We think there is no way that the marketing process [for hybrids] to the public at large will be compliant with DDO by October 5, so the potential IPO market for hybrids may become smaller.”
Oversight of distribution channels is one of the big issues. In a note to clients, Hall & Wilcox lawyers Vince Battaglia and Nina Mao said: “We understand from speaking with our clients that many product issuers do not have full visibility over the distribution of their products by financial advisers, in particular unaligned advisers with whom the issuers have no contractual or other relationship.
“Drafting meaningful and practicable distribution conditions and reportable information requirements can be difficult. This is because distributors can be of various types (for example, platforms, dealer groups and third-party websites) and each can have varying capacities to implement the distribution conditions (depending on their own level of resources and their IT capability).”
One sector that will be facing regulatory oversight for the first time is the buy now pay later industry.
Zip Co chief operating officer Chris Patrick said that because Zip had always done a full credit assessment on applicants he did not expect the DDO to be a big shock to the system.
But Patrick said Zip was still taking legal advice on whether its merchant partners are “distribution channels” for the purposes of DDO.
“Our view is that we do not have a store distribution model because the customer deals directly with us. The customer goes to our website and we control how the product is sold,” he said.
Last week, ASIC issued updated guidance for licensees preparing for DDO. The regulator said it will take a “reasonable approach” in the early stages of the reforms, “provided industry participants are using their best efforts to comply”.