ASIC Report 384

March 2014

Regulating complex products - is further regulatory reform on the horizon?

This Insight provides an overview of ASIC Report 384: Regulating complex products, in which ASIC outlines the approach it has taken to date in relation to regulating complex products, and identifies the areas where it will be focussing in the future. In this Insight we explore the potential implications of the Report for manufacturers and distributors of complex products.

What will constitute a "complex" product in ASIC's eyes? In the Report ASIC identifies a number of specific products which it categorises as complex - namely structured products, hedge funds, hybrid securities, warrants, exchange-traded options strategies and leveraged derivatives such as contracts for difference. ASIC also considers that a product will be "complex" if:

  • it has a structure or features that many retail investors find difficult to understand: the industry and ASIC often have quite different views on this point, so industry may wish to consider taking a fairly conservative view here; and
  • the product's structure makes it hard to assess the product's potential performance and risks (e.g. the product offers a qualified capital guarantee or capital protection, it involves complicated legal structures or performance depends on the interaction of multiple underlying components, indices or triggers).

ASIC's focus on complex products is nothing new and ASIC has already issued disclosure benchmarks intended to improve disclosure to retail investors about certain complex products, such as contracts for difference and hedge funds. However, what emerges clearly from the Report is that ASIC is seeking to tighten up its regulation of complex products even further, by:

  • at first instance, initiating further discussion with industry on the scope of the risks that complex products pose for retail clients and how these risks can be effectively managed; and
  • encouraging the manufacturers and distributors of complex products and those involved in advising on complex products, to consider the risks outlined in the Report in the context of their business. We think that itfs in this context that ASIC is flagging the potential for future regulatory reforms - see below for more discussion.

ASIC's focus seems to reflect a global trend of increasing focus on the regulation of complex products. For example, IOSCO has also been looking at the regulation of retail structured products and in December 2013 released a report in which IOSCO proposes a number of regulatory tools that regulators may wish to consider using when regulating structured products.

Two factors appear to be driving ASIC's ongoing and heightened focus on complex products:

  • first, a concern that complexity in financial products may obstruct ASIC's strategic priorities of promoting confident and informed investors and financial consumers and fair and efficient financial markets; and
  • secondly, the view that complexity in products can increase the likelihood that retail investors will not sufficiently understand the risks associated with a product and so this will affect their ability to make an informed investment decision. If an investor acquires a product that they donft understand and which is riskier than they appreciate, then this can expose them to unexpected losses.

ASIC sees behavioural economics as underlying this: namely the theory that, when faced with complexity, people are inclined to simplify the decision-making process. This means that they donft focus as much on the more difficult to understand information (e.g. in a product disclosure statement) and give undue weight to more readily-understandable information, such as that contained in advertisements. Accordingly, it's increasingly clear that ASIC considers that disclosure is no longer enough alone to ensure that retail investors make informed investment decisions about complex products. Moreover, ASIC will in future be focussing on each stage of the "lifecycle" of complex products, namely:

  • product development (i.e. the design and origination of products): ASIC wants to minimise the risk of poorly-designed products entering the market by providing guidance to assist with the product development process for product manufacturers;
  • product distribution: ASIC wants to avoid complex products being offered to investors via inappropriate distribution channels, including unlicensed distributors. ASIC is also concerned about disclosure which is not clear, concise and effective and which is misleading or deceptive and will continue to undertake surveillance and monitoring of product disclosure and advertising;
  • point of sale: the issue for ASIC is whether an investor receives any advice, or only poor-quality advice, in connection with a complex financial product which may not be suitable for them. ASIC will continue to monitor the quality of advice recommending investing in complex products and may look at the merits of investor self-assessment tools to assist investors to test their understanding of complex products before investing; and
  • post sale: ASIC believes there is a risk that some investors do not receive any ongoing information about a complex product, which could be very important for them in deciding whether or not to continue to hold or dispose of a product.

Both manufacturers and distributors of complex financial products should ensure that they carefully consider the issues raised by ASIC in the Report, especially in relation to the different stages of the product life cycle, to see if there are any areas where they could improve their own business practices. Of course, they should also ensure that they participate in any future consultation ASIC undertakes with industry concerning the regulation of complex products, to ensure that they have a say in any potential future reforms.

Overall, there is a clear message emanating from the Report - that unless industry takes account of ASIC's concerns and voluntarily makes some changes to how they develop, distribute and sell complex products to retail investors - as well as how they deal with retail investors post-sale - then there is a real chance that ASIC will take action for them, including by issuing further guidance on ASIC's expectations and/or seeking the Government's support for further reforms.

Nikki Bentley

I understand the financial services industry and thrive on helping our clients in this industry succeed.

Nikki Bentley Partner

Nikki is the Group Leader of Henry Davis York's Corporate Group, which includes the legal teams for Corporate / Mergers & Acquisitions; Investments & Financial Services and Tax.

Nikki is a leading investment funds advisor specialising in financial services and corporate law.  She specialises in business establishment and structuring, fund establishment, funds merger and acquisition, product disclosure and distribution. Nikki leads HDY's corporate group which combines expertise from the Financial Services, M&A and Tax areas.

Nikki provides advice to leading Australian and global fund managers on a full range of corporate, commercial and regulatory issues facing their businesses. She has considerable experience in assisting clients with fund establishment (onshore and offshore), disclosure and distribution. Nikki regularly advises clients on establishing, buying, selling and restructuring their businesses. She also regularly assists clients responding to regulatory enquiries and investigations.

With more than 15 years funds management experience in private practice, government and as an in-house lawyer, Nikki's practice spans the range of funds management products, with particular expertise in hedge funds, property funds and equities.

Nikki is regularly involved in industry and government discussions on regulatory reforms impacting the Australian funds management industry. Nikki is a passionate advocate for the development of a new corporate collective investment vehicle because of the opportunities it could provide to grow the funds management industry. She is the Honorary Legal Counsel and Chair of the Regulatory Committee for the Australian branch of the Alternative Investment Management Association (AIMA) and is a regular participant on the Financial Services Council (FSC) working groups.

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Jon Ireland

I constantly strive for technical excellence and commercial outcomes that add real value for my clients.

Jon Ireland Partner

Jon has extensive experience in corporate and financial services law, specialising in complex transactions, funds management and investment distribution. Jon also advises on regulatory issues relating to the use of technology in financial services.

Jon provides advice to leading Australian and international financial services clients on the full range of corporate, commercial and regulatory issues facing these businesses. He has considerable experience advising them on establishing, buying into, selling and restructuring their businesses.

Jon regularly advises on funds management issues including fund structuring, disclosure, investment management and outsourcing arrangements. He has particular expertise in the area of investment distribution and has advised on key projects for platform operators and advice providers.

Recently, Jon has advised on the establishment of a fully digital investment platform, the negotiation of a material outsourcing arrangement for a global investment bank and a scheme modernisation project for a leading Australian fund manager. Jon has also recently advised on the establishment of the Australian operations of a global diversified financial services business, including regulatory and corporate issues related to its expansion.

Jon's clients value his advice on recent law reforms, including around product disclosure statements and the digital provision of financial services. Jon is consulting to the Committee for Sydney and is a regular participant on Financial Services Council working groups.

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