New laws to regulate margin lending
An exposure draft1 of the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 (Bill) which was released on 7 May 2009 sets out a national regulatory regime for margin loans. The Bill also transfers regulation of trustee companies from the states and territories to the Commonwealth and amends the regulation of debentures and promissory notes.
Key features of the margin lending regime are:
- Chapter 7 of the Corporations Act 2001 (Cth) (Corporations Act) will apply to ‘margin lending facilities’ so that margin lenders and people who provide advice on margin lending will need to hold an AFSL with specific authorisations
- new responsible lending requirements will apply for retail clients
- lenders will need to notify retail clients of a margin call unless there is an express agreement in place for another AFSL holder (eg the financial adviser) to receive the communication
- three types of ‘margin lending facilities’ are captured by the regime, and
- submissions on the Bill are due by Friday 29 May 2009 and the Bill is expected to be introduced into Parliament in June 2009.
Further detail on each of these aspects is set out below.
What is the impact of the Bill on margin lenders?
Chapter 7 of the Corporations Act extended to margin lending facilities
The Bill extends Chapter 7 of the Corporations Act to margin lending by explicitly including a ‘margin lending facility’ as a financial product. This means that providers of financial services in relation to margin loans will be subject to the licensing, conduct and disclosure requirements in Chapter 7 and supervision and enforcement action by ASIC in relation to their margin loan products.
At a practical level providers of financial services, such as lenders and advisers, will be required to hold an Australian Financial Services Licence (AFSL) with a specific authorisation allowing them to provide financial product advice in relation to and deal in (by issuing – which is largely equivalent to lending) ‘margin lending facilities’.
Bringing margin loans within Chapter 7 will also impose the conduct and disclosure requirements of Chapter 7 on lenders and advisers in relation to margin loan facilities including the need to:
- comply with general conduct standards, including the requirement to deal with investors efficiently, honestly and fairly, manage conflicts of interest and ensure that their representatives are appropriately trained and qualified in relation to margin lending
- be subject to enforcement provisions in relation to market manipulation, false and misleading statements, inducing investors to deal using misleading information and engagement in dishonest, misleading or deceptive conduct, and
- provide appropriate disclosure to retail clients before and after a product is purchased, including providing a PDS, FSG and SOA (as applicable) and periodic statements on an ongoing basis.
Additional information that must be included in FSGs, SOAs and periodic statements relating to margin loan facilities are set out in the Regulations released with the Bill. ASIC plans to release a simplified margin lending PDS.
Margin lenders who already hold an AFSL for other purposes will need to review their policies and procedures in light of this to ensure that they comply with their obligations as AFSL holders in relation to their margin loan products. Margin lending product specific PDSs, FSGs, SOAs and periodic statements will also need to be prepared.
Margin lenders and advisers who do not currently hold an AFSL will need to apply for an AFSL.
New responsible lending requirement for retail clients
A significant aspect of the regime is the new responsible lending requirement that will apply to the issue of a margin lending facility to a retail client and the increase in the limit of a margin lending facility (essentially the maximum amount that a client can borrow under the loan) that was issued to a retail client. The provisions are aimed at ensuring that retail clients do not take on loans that they cannot service.
Before issuing a margin lending facility or increasing the limit of a margin lending facility the AFSL holder will need to make an assessment as to whether the facility will be unsuitable for the retail client.
Before making the assessment the AFSL holder will need to make reasonable inquiries about the retail client’s financial situation, take reasonable steps to verify that information and make certain inquiries prescribed by the Regulations including, for instance, whether the client has taken out a loan to fund the equity contribution (double gearing) and, if so, whether the security for the loan includes residential property.
The assessment is to be based on the facts as they exist at the time of the assessment and there is no requirement to make assumptions about potential future developments.
A margin lending facility will be unsuitable if in the event that a margin call arises it is likely that the client would not be able to service the loan or would only be able to do so with ‘substantial hardship’ (this is undefined).
If a margin loan facility is assessed as unsuitable, it must not be provided to the client. Failure to comply with this requirement is an offence carrying penalties of 200 penalty units or imprisonment or both.
In connection with these new requirements, the government is seeking specific feedback on whether there should be a definitive credit limit for margin lending.
Lender to notify retail clients of a margin call
The Bill makes it clear that the lender must take reasonable steps to notify a retail client of a margin call unless there is an express agreement with the client that another AFSL holder (such as their financial adviser) will receive the communications in which case the lender must notify the financial adviser who must take reasonable steps to notify the retail client.
The Bill sets out procedures for when and how the notice is to be given.
What is caught by the regime?
As set out above, the Bill includes ‘a margin lending facility’ in the list of specific facilities that are financial products. The Government proposes to regulate the following three types of margin lending facilities.
Standard margin lending facility
Under a standard margin lending facility:
- credit is provided to a person (client)
- the client intends to use the credit wholly or partly to acquire financial products (or a beneficial interest in financial products) or to refinance a margin lending facility
- the loan is secured wholly or partly by marketable securities (or a beneficial interest in marketable securities) (secured property), and
- the client is subject to a ‘margin call’ in circumstances where the current loan to value (LVR) ratio of the facility exceeds the agreed threshold.
The ‘current LVR’ is the ratio of the outstanding debt owing by the client, or credit provided by the provider (or both) to the value of the secured property provided for the loan.
The legislation places emphasis on the purpose to which the loan will be put (it must be investment related) and what is to be used as collateral in determining whether a facility is a ‘standard margin lending facility’.
The government is seeking specific feedback on how to address the issue of client intention in relation to the use of funds.
Non-standard margin lending facility
Under a non-standard margin lending facility:
- a person (client) transfers marketable securities (or a beneficial interest in marketable securities) to the provider
- the provider transfers property to the client as consideration for the transferred securities
- the transferred property is, or may be, used by the client to acquire financial products (or a beneficial interest in financial products)
- the client has a right to be given marketable securities equivalent to the transferred securities, and
- the client is subject to a ‘margin call’ in circumstances where the ‘current LVR’ of the facility exceeds the agreed threshold.
The ‘current LVR’ is the ratio of the value of the transferred property and any amount owing by the client to the provider to the value of the transferred securities provided by the client.
Non-standard margin lending facilities are intended to capture Opes Prime and Tricom style arrangements.
A facility declared by ASIC to be a margin lending facility
If ASIC makes a declaration, it must define what the margin call and limit is in relation to that kind of facility. In the government’s view, ASIC requires these powers in order to deal with product innovation and developments.
Other arrangements that the new definitions are intended to capture include the basic or ‘vanilla’ margin loan, protected equity margin loans to a degree less than 100 per cent (for example, margin loans with a put option to mitigate the risk of the share portfolio), hybrid products that utilise the key features of a margin loan, a limited or non recourse margin loan (where the amount the lender can recover is restricted to the mortgaged financial product) and a margin loan where the assets securing the loan are more than just the financial products purchased through the loan, such as residential property.
What is excluded?
Certain types of general investment and other loans are excluded from the scope of definitions. There must be a link to investment lending, such as the purchase of financial products, for a loan to be considered a ‘margin lending facility’. It is intended that more general forms of investment lending will be addressed in the government’s broader credit reforms.
Examples of general investment lending excluded from the definition of a ‘margin loan facility’ are:
- a loan secured against a residential or investment property and used to purchase securities, and
- where general consumer lending (such as a personal loan or credit card) is wholly used to purchase an investment product.
Margin lending facilities are also not intended to capture margin loans solely for personal, domestic or household use or non investment business purpose, such as a farming business.
It appears that most warrants and structured products will not be caught by the definition of a ‘margin lending facility’ provided they do not contain a current LVR provision. It will be important to review the terms of your products to determine whether they contain such provisions, particularly in relation to products that allow for early repayment.
Timing and application
The Corporations Act will apply to margin lenders and advisers three months after the new legislation is enacted which is expected to be later this year.
ASIC applications for obtaining a licence are not to be made until one month after the new legislation is enacted but must be submitted no later than three months after the legislation commences.
Special interim arrangements will then apply until ASIC issues a licence. During this time, the lender and adviser may continue to lend and advise on margin lending facilities even without holding a licence and without being subject to the Chapter 7 requirements, except responsible lending and notification requirements.
The new laws are intended to apply prospectively. Lenders will not be required to issue PDSs or FSGs for existing margin lending facilities. However requirements under the new laws will be triggered for existing margin loans where for example there is an increase in the credit limit (the new responsible lending provisions will apply) and where there is a margin call (the notification requirements will apply). Ongoing obligations such as in relation to issuing periodic statements will also apply.
The government is seeking specific feedback on the suitability of these arrangements.
Other changes
The Bill also harmonises the regulation of:
- Trustee companies: a new chapter 5D is to be inserted into the Corporations Act to transfer regulation of trustee companies from the States and Territories to the Commonwealth, and establish a national consumer protection and disclosure regime.
- Debentures and promissory notes: a promissory note with a face value of at least $50,000 is to be included under the definition of a debenture, and a publicly available register of trustees for debenture holders is to be established.
Endnotes
1. Exposure draft of the Bill
This article was written by Philippa Stone, Partner and Alison Wheatley, Senior Associate, Sydney.
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