Strengthen product issuer and distributor accountability

Recommendation 21

Introduce a targeted and principles-based product design and distribution obligation.


Government should amend the law to introduce a principles-based product design and distribution obligation.2 The obligation would require product issuers and distributors to consider a range of factors when designing products and distribution strategies. In addition to commercial considerations, issuers and distributors should consider the type of consumer whose financial needs would be addressed by buying the product and the channel best suited to distributing the product. Industry should supplement this principles-based obligation with appropriate standards for different product classes.

The obligation would cover:

  • During product design, product issuers should identify target and non-target markets, taking into account the product’s intended risk/return profile and other characteristics. Where the nature of the product warrants it, issuers should stress-test the product to assess how consumers may be affected in different circumstances. They should also consumer-test products to make key features clear and easy to understand.
  • During the product distribution process, issuers should agree with distributors on how a product should be distributed to consumers. Where applicable, distributors should have controls in place to act in accordance with the issuer’s expectations for distribution to target markets.
  • After the sale of a product, the issuer and distributor should periodically review whether the product still meets the needs of the target market and whether its risk profile is consistent with its distribution. The results of this review should inform future product design and distribution processes. This kind of review would not be required for closed products.3

These requirements would be scalable, depending on the nature of the product. Compliance with this obligation should be straightforward for simple products that are likely to be suitable for most consumers. For example, simple, low-risk products such as basic banking products would not require extensive consideration and may be treated as a class, with a standard approach to their design and distribution.

A serious breach of this obligation should be subject to a significant penalty.


  • Reduce the number of consumers buying products that do not match their needs, and reduce consequent significant consumer detriment.
  • Promote fair treatment of consumers by firms that design and distribute financial products.
  • Promote efficiency and limit or avoid the future need for more prescriptive regulation.
  • Build confidence and trust in the financial system.


Problem the recommendation seeks to address

The existing framework relies heavily on disclosure, financial advice and financial literacy. However, disclosure can be ineffective for a number of reasons, including consumer disengagement, complexity of documents and products, behavioural biases, misaligned interests and low financial literacy.4 Many consumers do not seek advice, and those who do may receive poor-quality advice. Many products are also distributed directly to consumers.

Such issues have contributed to consumer detriment from financial investment failures, such as Storm Financial, Opes Prime, Westpoint, agribusiness schemes and unlisted debentures, which have affected more than 80,000 consumers. Losses from these failures totalled more than $5 billion, or $4 billion after compensation and liquidator recoveries.5 Although these losses have a number of contributing causes, poor product design and distribution practices that disregarded consumer behavioural biases and information imbalances played a significant role. A recent independent report on improving consumer compensation arrangements identified scope to make product issuers more responsible for product distribution.6 Although FOFA has made significant changes to reduce incentives for inappropriate distribution where personal advice is provided, more can be done during the product design phase to complement these measures.

The current quality of product design and distribution controls is variable. ASIC’s report on Regulating Complex Products observed that some consumers acquire structured products that are riskier than they realise.7 For example:

  • Insufficient information provided in the disclosure documents, advertising and seminars relating to over-the-counter contracts for difference (CFD) made it difficult for retail consumers to make informed investment decisions.
  • Some firms distributing hybrid securities included sales information in addition to, or inconsistent with, the information in the prospectus. This information tended to emphasise high yield while downplaying risk.

The Inquiry is also concerned that certain less complex add-on insurance products may not meet the needs of some consumers. For example, an ASIC report revealed Consumer Credit Insurance (CCI) products being bought by consumers whose situation made them ineligible to claim under the policy.8 The Financial Ombudsman Service (FOS) found that 11 per cent of claims on CCI products were declined, compared with 3 per cent of all personal general insurance claims.9

A number of recent high-profile ASIC enforceable undertakings (EUs) demonstrate some firms had serious compliance issues in providing personal advice and internal controls.10 Although these examples raise potential breaches of the personal advice regime and occurred before the significant FOFA changes, they also demonstrate weaknesses in processes for, and controls on, product distribution to consumers that are not limited to the provision of personal advice.

The financial services industry has already attempted to address this problem through broader risk management processes and specific initiatives. For example, the Australian Financial Markets Association (AFMA) has developed product approval principles for retail structured finance products. However, these do not cover all issuers and distributors, and, in any event, are not enforceable.11

This recommendation takes into account the Senate Economics References Committee’s report on ASIC’s performance. The Senate Committee suggested that urgent attention should be given to providing ASIC with the necessary toolkit to prevent consumer detriment by subjecting the product issuer to more positive obligations in regard to the suitability of its product.12


To improve consumer outcomes, the framework should promote the targeting of products to those consumers who would benefit from them. This would reduce the incidence of consumers buying products that do not match their needs, building consumer confidence and trust in the financial system. It would also benefit individual firms by improving customer relationships.

Options considered

The Inquiry raised two options in its Interim Report to reduce the number of consumers buying products that do not match their needs:

  1. Recommended: Introduce a targeted product design and distribution obligation.
  2. Introduce individual appropriateness test at point of sale for complex products.

In response to the Interim Report, submissions also suggested the following additional option:

  1. Implement a new obligation through a fully self-regulatory approach by setting expectations for industry and monitoring their progress, with regulatory follow-up if progress is not made.

Option costs and benefits

Introduce a targeted product design and distribution obligation

Increasing the accountability of product issuers and distributors in this way would boost consumer confidence and trust in the system, and is supported in submissions by many consumer groups and financial advice groups. However, industry submissions note that many firms already have sophisticated controls in place, and regulatory intervention would increase product costs or decrease product offerings for consumers.13 Submissions from issuers, distributors and industry groups also raise concerns about the difficulty for product issuers in determining the suitability of products and the additional compliance cost involved with introducing the new obligation. Firms believe their processes would need to be reviewed even if they already have controls in place.

However, the Inquiry notes the proposed obligation is likely to have substantial benefits for consumers. As discussed earlier, in conjunction with other measures, a product issuer and distributor obligation could reduce the incidence of cases such as:

  • Storm Financial, where margin lending products did not suit consumer risk profiles, such as those approaching retirement who could only cover significant losses by selling the family home. Close to 2,800 consumers faced around $500 million net losses.14
  • Opes Prime, where complex securities lending arrangements were not understood by consumers. As a result, hundreds of clients, many of whom were retail consumers, faced close to $400 million net losses.15

The Inquiry considers that industry concerns about implementation costs can be dealt with by ensuring the obligation builds on good practice, is principles-based and is applied on a scaled basis, allowing scope for firms to adapt their existing practices. Thus, the new obligation would impose minimal costs on firms with existing good practices. Some incremental costs for industry may include client categorisation, record keeping, updating documentation and staff training, as well as monitoring changes in the external environment. In addition, the regulator would require additional resources to establish initial guidance and monitor compliance.

Some stakeholders suggest that a new obligation of this kind should be limited to the design and distribution of complex products. Although many of the recent cases of concern involve distribution of complex products to retail clients, examples of concern have also included distribution of less complex products such as add-on insurance and debentures. Recent EUs have raised concerns with the quality of distribution plans for credit cards.16 The Inquiry’s view is that the obligation should not be restricted. As a matter of principle, the proposed obligation should be universal in its nature and scalable in line with the nature of the product.

This option would deliver benefits to industry, including strengthening internal risk management for product design, which may mitigate future problems, as well as signalling a higher level of customer focus. This approach should also avoid new, more complex and interventionist regulation in the future, promoting efficiency in the financial system overall.

This recommendation aligns with policy objectives in peer jurisdictions; however, the Inquiry has taken a principles-based approach that is less prescriptive. The European Union and the United Kingdom have introduced regulated product governance arrangements, and the International Organization of Securities Commissions has suggested that issuers evaluate whether their general distribution strategy is appropriate for the target market, particularly for structured products.17 The United Kingdom recently assessed compliance with the new product governance obligation, suggesting that although firms’ processes and procedures are of variable quality, the obligation is playing a positive role in focusing firms on consumer needs.18

Introduce individual appropriateness test at point of sale

In the European Union, an individual product appropriateness test is being introduced for product issuers and distributors at point of sale.19 An appropriateness test requires the assessment of some of an individual’s personal circumstances before making the product available to them. In Japan, Hong Kong and Singapore, intermediaries are required to assess consumers’ knowledge and experience of certain complex products before providing services to them.20 In the United States, the Financial Industry Regulatory Authority has introduced heightened supervision expectations on issuers and distributors for complex products.21

An individual appropriateness test, where no personal advice is provided, would introduce significant costs for issuers and distributors due to necessary changes to the sales process. Appropriateness tests are also open to manipulation. The Inquiry believes that the objective can be achieved by taking a principles-based approach to product design and distribution that is less prescriptive.

Implement new obligation through a fully self-regulatory approach

This option would build on the recent work of AFMA, relying on the financial services industry to monitor how standards are applied and take relevant disciplinary action if required. However, recent experience with industry self-regulation in the financial sector suggests that improving the design and distribution of products for consumers would not be achieved by self-regulation alone.

The Inquiry considers that past industry-led standards have not been sufficient by themselves to address serious conduct issues; for example, managing conflicts in financial advice driven by remuneration. Despite efforts over many years, the financial advice industry failed to improve financial advisers’ conduct, leaving it unable to prevent or reduce the effect of recent serious cases of poor advice.

Although AFMA standards on product approval practices are valuable, they do not cover the whole industry and are not subject to substantive monitoring and enforcement. Self-regulation alone would also fail to underscore the importance of this recommendation to improve consumer outcomes.


Product issuers and distributors are best placed to understand the features of a product and its appropriate target market. Introducing a targeted design and distribution obligation for all products would decrease the number of consumers buying products that do not meet their needs, and would make the industry more customer-focused in product design. Therefore, the Inquiry recommends introducing a principles-based regulatory obligation that enables industry to develop standards of practice tailored to product classes.

The Inquiry recognises that some firms have already made significant progress in designing products for and distributing products to suitable target markets. For firms that are already designing products and distribution strategies in this way, the new obligation is not likely to have a significant effect. The Inquiry considers that this best-practice approach taken by some firms should become standard practice.

Implementation considerations

This recommendation should not limit the kinds of products that could be developed and issued. The Inquiry supports the role of innovation and its benefits to consumers. The new obligation would help target innovative products to consumers whose needs align with product features. This may mean certain products are not marketed to certain kinds of retail consumers, or are not marketed to consumers unless certain conditions are met — an approach consistent with existing good practice.

This recommendation should also be considered in conjunction with other recommendations in this report, particularly those in Chapter 5: Regulatory system. Implementing this recommendation would require adequate regulator capabilities to review financial firms’ internal controls and to understand the relevant product markets and consumer behavioural biases.

Circumstances beyond those reasonably foreseeable at the time would not be expected to be taken into consideration by issuers and distributors.

2 This obligation would not apply to credit products regulated under the National Consumer Credit Protection Act 2009, because the responsible lending obligation currently requires assessment of suitability on an individual basis.

3 Closed products are those not accepting new customers or funds, of which legacy products are a subset.

4 Commonwealth of Australia 2014, Financial System Inquiry Interim Report, Canberra, page 3–57.

5 These figures include losses involving the more substantive cases of financial investment failures in the last 10 years, such as Storm Financial, Opes Prime, Westpoint, Great Southern, Timbercorp and Banksia Securities.

6 Commonwealth of Australia 2012, The Treasury, Compensation arrangements for consumers of financial services, report prepared by R St John, Canberra, pages 149–150.

7 Australian Securities and Investments Commission (ASIC) 2014, Report 384: Regulating complex products, ASIC, Sydney, page 4.

8 Australian Securities and Investments Commission (ASIC) 2011, Report 256: Consumer credit insurance: A review of sales practices by authorised deposit taking institutions, ASIC, Sydney, pages 22–23.

9 Financial Ombudsman Service (FOS) 2014, General Insurance Code of Practice: Overview of the year 2012/2013, FOS, Melbourne, page 51.

10 For example, Australian Securities and Investments Commission (ASIC) 2011, Enforceable Undertaking (EU) with Commonwealth Financial Planning Limited, 25 October; ASIC 2011, EU with UBS Wealth Management Australia Ltd, 17 March; ASIC 2013, EU with Macquarie Equities Ltd, 29 January.

11 Australian Financial Markets Association (AFMA) 2012, Principles relating to product approval — retail structured financial products, AFMA, Sydney.

12 The Senate Economics References Committee 2014, Performance of the Australian Securities and Investments Commission, Commonwealth of Australia, Canberra, pages 442–443.

13 Australian Bankers’ Association 2014, Second round submission to the Financial System Inquiry, page 50.

14 Australian Securities and Investments Commission 2014, First round submission to the Financial System Inquiry, page 191.

15 Australian Securities and Investments Commission 2013, Verdict in Opes Prime director trial, media release, 6 September.

16 Australian Securities and Investments Commission 2012, Enforceable Undertaking with Commonwealth Bank of Australia, 6 March.

17 European Securities and Markets Authority (ESMA) 2014, Consultation Paper: MIFID/MiFIR, ESMA, Paris, page 39; Financial Conduct Authority (FCA), Regulatory Guide: The responsibilities of providers and distributors for the fair treatment of consumers, FCA, London; International Organization of Securities Commissions (IOSCO) 2013, Report FR 14/13 Regulation of retail structured products, IOSCO, Madrid, pages 43,52.

18 Financial Services Authority (now the Financial Conduct Authority) (FCA) 2012, Retail product development and governance — structured product review, FCA, London, page 11.

19 European Securities and Markets Authority (ESMA) 2014, Consultation Paper: MIFID/MiFIR, ESMA, Paris, page 136.

20 Australian Securities and Investments Commission (ASIC) 2014, Report 384: Regulating complex products, ASIC, Sydney, page 41.

21 Financial Industry Regulatory Authority (FINRA) 2012, Regulatory notice 12-03: Heightened supervision for complex products, FINRA, Washington DC, pages 5–6.