03 Oct 2019

ECM by Design: Equities and capital raising under the Design and Distribution Obligations regime

By Andrew Hay, Clayton Barrett

Equity issuers, advisers and underwriters should start thinking about how the DDO regime is going to affect the way that capital raisings are conducted.

The Design and Distribution Obligations (DDO) regime commences on 5 April 2021.

A wide range of equity products will be subject to the DDO regime and it will have significant implications for many capital raisings.

Despite the familiar refrain to "Please read the Prospectus/PDS carefully and consider whether an investment is right for you”, for those equity products subject to the DDO regime, it will no longer be enough to give retail investors enough disclosure to decide whether an investment is right for them – issuers and distributors will now have an explicit responsibility to offer the right products to the right investors.

Equity issuers, advisers and underwriters should start thinking about how the DDO regime is going to affect the way that capital raisings are conducted.

How does the Design and Distribution Obligations (DDO) regime apply to equities?

The Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 (DDO PIP Act) was passed in April 2019.

It introduced the DDO regime in a new Part 7.8A "Design and distribution requirements relating to financial products for retail clients" of the Corporations Act.

The DDO regime commences on 5 April 2021.

The core elements of the DDO regime are:

  • Design obligations: on the issuer or other person responsible for preparing the disclosure document, requiring products to be designed for an appropriate target market. The design obligations are centred around a "Target Market Declaration" to be prepared for the particular product;
  • Distribution obligations: on brokers and other persons who engage with potential retail investors, requiring retail product distribution conduct to be consistent with the Target Market Declaration for the product.

A breach of the provisions may give rise to a range of remedial orders, including for compensation, as well as civil penalties or criminal prosecution.

Meeting the DDO requirements will require a documented customer-driven approach to designing, marketing and distributing relevant equities products to retail investors.

This will effectively add an additional layer to the due diligence process adopted for the capital raising.

We will outline the process and steps required in more detail in a later edition of Insights.

Which equities products will be subject to the DDO regime?

As it stands, equity products that will be regulated by the DDO regime include:

  • Preference shares, convertible notes or other hybrid securities offered under a prospectus;
  • Options offered under a prospectus;
  • Partly-paid Ordinary Shares offered under a prospectus;
  • Fully-paid Ordinary Shares in an "investment company" offered under a prospectus. This applies where the issuer is a listed or unlisted company that carries on a business of investment in financial products, land or other investments and raises funds from the public[1] on that basis. For example, a "listed investment company" (LIC);
  • Debentures or Notes offered under a prospectus (or without a prospectus if debentures of an Australian authorised deposit-taking institution (ADI) or a registered Life Insurance company*);
  • Simple Corporate Bonds offered under a two-part simple corporate bond prospectus (and depository interests in those simple corporate bonds); *
  • Units in unit trusts and other managed investment products offered under a product disclosure statement (PDS);
  • Stapled securities offered under a combined prospectus and PDS (as stapled unit(s) are currently subject to the DDO regime, even though fully-paid ordinary shares are generally excluded as outlined below);
  • Structured products offered under a PDS; and
  • Custodial arrangements not covered above, including an interest in an investor directed portfolio service (IDPS)*.

Although the regulatory treatment of "tokens / coins" under a "token sale / initial coin offering" (ICO) depends upon the rights and other features of the particular tokens or coins offered, if a PDS or prospectus is required for a particular ICO, it seems likely that the new design and distribution laws will apply.

* Proposed to be added by Regulation based on the revised exposure draft Regulations issued for consultation on 12 September 2019.

Which equities products are excluded?

The most significant equity capital markets exclusions from the new DDO regime are:

  • fully-paid ordinary shares in an Australian or foreign company, where the company is not an "investment company";[2]
  • depository interests in fully-paid ordinary shares in a foreign company, where the underlying ordinary shares would be excluded from the regime;[3]
  • securities issued under an employee share scheme. To meet the definition of "employee share scheme", the securities must be fully paid ordinary shares, units in fully paid ordinary shares, or options issued for nominal consideration for such shares;
  • margin lending facilities and MySuper products, as these are subject to existing product-specific regulation;
  • financial products offered under a New Zealand disclosure document under the mutual recognition scheme;<[4]
  • wholesale offers that do not require a prospectus, PDS or other disclosure document.[5]

The above is subject to any changes from the latest round of Treasury consultation on the Regulations, the final Regulations and any relief granted by ASIC upon implementation of the new laws.

Something to say about the proposed equities products subject to the DDO regime?

The equity product inclusions and exclusions above reflect the DDO PIP Act as passed into law, plus the Government’s proposed modifications set out in revised exposure draft Regulations issued for consultation on 12 September 2019.

Consultation on the exposure draft Regulations is open until 11 October 2019.

How does the DDO regime fit with the Product Intervention Powers (PIP) regime?

The DDO PIP Act also introduced the Product Intervention Powers (PIP) regime which from 6 April 2019 has given ASIC new powers to issue a product intervention order where ASIC is satisfied that a financial product has, will or is likely to result in significant financial detriment to retail clients.

The PIP regime is contained in a new Part 7.9A "Product intervention orders" of the Corporations Act.

The PIP regime applies to financial products (and credit products) more broadly, but equities products subject to the DDO regime will also be subject to ASIC’s powers under the PIP regime.

ASIC has already proposed to use its product intervention powers to ban the retail distribution of over-the-counter (OTC) binary options and to impose leverage limits and other conditions on the issue and distribution of contracts for difference (CFDs). (Consultation on these proposals remains open until 1 October 2019).

[1]The "public" is defined in section 82 of the Corporations Act so as generally to include any section of the public, whether selected as clients of the offeror or selected in another manner, but excluding a bona fide offer to certain persons such as an underwriter or to a person whose ordinary business is to buy or sell shares, debentures or managed investment products.Back to article

[2]As an anti-avoidance measure, the exclusion for "fully paid ordinary shares" also does not apply to issues where the company intends the fully paid ordinary shares to be converted into preference shares within 12 months after issue.Back to article

[3] Proposed to be excluded by Regulation based on the revised exposure draft Regulations issued for consultation on 12 September 2019.Back to article

[4] The revised exposure draft Explanatory Statement to the revised exposure draft Regulation notes that ‘recognised offers’ made under the mutual recognition scheme in Chapter 8 of the Corporations Act because they are not subject to the Australian requirements to prepare a prospectus or PDS.Back to article

[5] As the regime is tied to the prospectus / PDS / disclosure document requirements, wholesale offers will typically be excluded unless the Regulations extend the regime to the product.Back to article

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.