Regulation of complex products

In its recently released 2014-2015 strategic outlook ASIC has noted its continuing focus on improving the design, disclosure, marketing and distribution of a range of financial products that are generally considered to be “complex” and have the potential to confuse clients.

Complex products have received ongoing attention over the last couple of years and ASIC’s Report 384 Regulating complex products (January 2014) and the Financial System Inquiry (FSI) report (December 2014) clearly express an expectation that complex product providers will need to do more than meet the standard regulatory obligations – they will need to consider the suitability and appropriateness of product design, distribution networks and disclosure having regard to their target clients.

In this update, in a context where the performance issues surrounding the Australian financial advice industry are well-publicised, we summarise the steps that have been taken to improve adviser accountability generally and ASIC’s additional proposals in relation to complex product regulation.

Key points

• Complex products include exchange-traded options strategies, hedge funds, hybrid securities, leveraged derivative products (eg, CFDs and margin foreign exchange contracts), managed funds with complex non-standard or non-linear payoffs, structured products, non-vanilla warrants and agribusiness managed investment schemes.
• ASIC has highlighted the risks complex products can pose to clients and the gaps in its powers to take administrative action against adviser
• A number of enhanced regulatory measures have been implemented, including a statutory best interests obligation, increased ASIC powers, targeted enforcement actions and an enhanced register of financial advisers.
• Proposed measures include ASIC powers to intervene in the design, marketing and distribution of products and developing the register of advisers.
• Complex product issuers may be required to consider whether their product design, distribution strategies and disclosures are appropriate for the needs and sophistication of target clients.
• The currently regulatory shake-up is progressing in a climate of building domestic and global fund manager interest in the Australian financial advice sector as managers consider their business models on the advice (as opposed to product) side.

What is coming?

Intervention powers

A proposed product intervention power for ASIC to improve the design and distribution of financial products.  The proposed power is described in the FSI report as “a last resort or pre-emptive measure where there is risk of significant detriment to a class of consumers” and would allow ASIC to intervene in product offering processes to:

• require amendments to marketing and disclosure materials;
• require changes to warnings, labels or terminology;
• impose distribution restrictions; and
• enable certain products to be banned.

The current proposal is that the power would be limited to temporary intervention of 12 months (to be extended if needed) and would be subject to judicial review.

The UK Financial Conduct Authority has similar product intervention powers, as does the US Consumer Financial Protection Bureau.

There have not yet been any formal steps to further develop this proposal, however ASIC is continuing to press the federal government to grant it the power to enter institutions and change the design of financial products.

Financial advisers register – second stage

The first stage of the enhanced financial advisers register commenced on 31 March 2015 (see below).  Implementation of the second stage of the register will commence in May 2015, which will see advisers’ qualifications, training and professional memberships being uploaded to the register and being accessible by the end of May 2015.

Banning powers

While ASIC currently has power to ban persons or entities from providing financial services, there is a perceived gap in its powers to prevent a person from managing a financial services business.  In an environment where phoenix type activity occurs (senior people from a firm with poor operating practices establishing new businesses or moving to new firms) ASIC is pressing to expand its banning powers to address this gap.

What has already happened?

Financial advisers register – first stage

On 31 March 2015, ASIC launched the first stage of the financial advisers register, which is a publicly available register of financial advisers (being employees and officers of licensees and authorised representatives) authorised to provide personal advice to retail clients about certain complex products.

The register resolves a transparency gap, as neither consumers nor ASIC could readily determine whether an adviser was authorised to provide financial advice or had appropriate credentials. 

ASIC must be notified of the appointment of a financial adviser, and changes to their details, within 30 business days.  The obligation to notify falls on the appointing licensee (or the authorised representative in the case of a sub-authorisations).  Financial advisers are also required to provide all relevant information to licensees and authorised representatives necessary for them to comply with the notice requirement.  Failure to comply with the notification requirements is an offence.

Future of financial advice reforms

The FOFA reforms introduced a raft of changes relating to financial advice provided to retail clients aimed at improving investor trust and confidence and also the availability, accessibility and affordability of high quality advice.

• Providers of personal financial product advice to retail clients must act in the best interests of their clients.  They must provide appropriate advice, warn clients if advice is based on incomplete or inaccurate information and prioritise clients’ interests.
• To satisfy the best interests obligation, an adviser must (among other things) consider whether it would be reasonable to recommend a financial product having undertaken a reasonable investigation into the financial products that might achieve a client’s needs.  ASIC expects that more extensive inquiries will be undertaken to satisfy this requirement where the advice involves complex products or strategies.
• Conflicted remuneration structures are banned in relation to the distribution of, and advice about, a range of retail investment products.
• ASIC can refuse, cancel or suspend a licence where a person is likely to contravene licence obligations or a financial services law.
• ASIC can ban a person who is not of good fame and character or not adequately trained or competent to provide financial services.
• ASIC can ban a person who is involved, or is likely to be involved, in a contravention of obligations by another person.

Enforcement actions

In 2013, ASIC began a crackdown on the sale of complex products promoted as having capital protection or a capital guarantee following the findings summarised in ASIC Report 340: ‘Capital protected’ and ‘capital guaranteed’ retail structured products (May 2013) and Report 377: Review of advice on retail structured products (December 2013), which identified significant concerns around the marketing of complex capital protected products to retail investors.  ASIC found that some advisers promoting these products were not adequately considering the consumer's needs and circumstances and that, due to the complex nature of these products, some consumers did not understand what, if anything, was actually protected. 

Following the release of these reports:

• numerous product issuers amended or withdrew certain promotional materials for complex structured products;
• adviser conduct was reviewed;
• significant breach notifications were lodged with ASIC and remedial actions were undertaken;
• authorised representative appointments were terminated;
• compensation programs were implemented to compensate customers who received inappropriate advice about complex products;
• changes to systems and policies to improve advice on structured products and changes to record keeping practices were implemented; and
• certain products were removed from approved product lists.