AFMA Submission on Corporations Legislation Amendment
(Financial Services Modernisation) Bill 2009
– Margin Lending Facilities
29 May 2009
Table of Contents
1.
Executive Summary ............................................................................ 3
2.
Required Transition Period ................................................................. 6
3.
The Definition of Margin Lending ........................................................ 8
3.1. Client Declarations of Purpose ......................................................... 8
3.2. Scope of Purpose ........................................................................... 9
3.3. Current LVR Definition – A Possible Regulatory Loophole..................... 9
4.
Required Product Exclusions from Margin Lending ............................. 9
5.
Impact of Margin Lending Regulation on Wholesale Markets ........... 11
6.
Definition of Wholesale Client for Margin Lending ............................ 13
7.
Making the Unsuitability Assessment ............................................... 14
7.1. Distinguish between New Loans and Limit Increases ......................... 14
7.2. Recognition of Margin Lending Business Practices ............................. 15
7.3. Verification of Client Income........................................................... 16
7.4. Reliance on Information Provided by the Client ................................. 16
7.5. Restrictions on Availability of Internal Bank Information to the Margin
Lender................................................................................................. 17
7.6. Testing Unsuitability – Timing......................................................... 17
7.7. Extent of Reliance on Clients Assets ................................................ 18
8.
Client Access to Unsuitability Assessments ...................................... 19
9.
Substantial Hardship ........................................................................ 19
10. Unsuitability Tests and Personal Advice ........................................... 21
11. Information Provided in a Statement of Advice ................................ 21
11.1. Extent of Reliance on a Statement of Advice .................................... 22
11.2. Certification ................................................................................. 23
11.3. Timing Issues ............................................................................... 23
12. Margin Lending Disclosure Regime ................................................... 24
13. Notification of Margin Calls ............................................................... 24
14. Periodic Statements ......................................................................... 25
14.1. Loan Termination Value ................................................................. 25
14.2. Provision of Asset Valuations – A New Lender-Client Relationship........ 26
14.3. Provision of Asset Valuations – Creating New Risks for Retail Clients and
Lenders ............................................................................................... 27
14.4. Practical Problems ......................................................................... 28
14.5. Conventional Loans that are Unconventional Margin Loans ................. 28
15. ASIC Determinations and Guidance .................................................. 29
16. Other Issues ..................................................................................... 30
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1. Executive Summary
The Australian Financial Markets Association (AFMA) appreciates the opportunity
to contribute to the development of an effective regulatory regime for margin
lending, both through the long term consultation process and by providing
comment on the exposure draft legislation.
AFMA supports the Government's policy objectives in introducing new national
laws to regulate margin lending under a single, national regime. Margin lending
regulation that is implemented in keeping with the established principles of
Better Regulation will provide a greater level of consumer protection to retail
investors and assist margin loan providers by establishing minimum standards
and promoting investor confidence in the market. Regulation should preserve
the capacity for investors to utilise margin loans to manage their investments in
a flexible, timely and convenient manner.
AFMA’s members involved in the margin loan market aim to operate to a high
standard and service their clients in an efficient and responsible manner. This
necessarily includes procedures that support effective disclosure, proper margin
call notification procedures and good lending practices. This approach helps
investors to take responsibility for their decisions on an assured basis, which
promotes better risk management on their part and market efficiency. Hence,
our interest primarily lies in the technical design of the law and the practical
issues that it may present to lenders and their clients when it becomes
operational.
In this section we summarise a number of the key issues that need to be
addressed to develop legislation that is both efficient and effective. In the
following sections we present more detail on these issues and outline a range of
other matters that require attention before the legislation is ready for
introduction into Parliament.
Transition
The most pressing issue to be addressed is the inadequacy of the proposed
transition arrangements, which does not properly recognise the scale and scope
of the changes required to business practices and operating systems. The
practical problems margin loan providers would encounter cannot be overcome
effectively in a short time period, notwithstanding their serious commitment to
implement the new regime in a diligent and expedient manner.
Our assessment, based on discussions with member firms, is that a transition
period of at least 18 months will be required to deliver the desired policy
outcomes in an efficient and assured manner for both margin loan providers and
their clients.
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Avoid Applying Margin Loan Regulation to Wholesale Financial Markets
The definition of margin loan should be amended cover only loans to retail
clients. This approach would achieve the stated policy purpose and neatly avoid
the cost of unnecessary interference in the wholesale financial markets, like that
for derivatives, which are adequately covered by existing regulation anyway.
Unsuitability Tests
An effective risk based approach to assessing unsuitability would deliver a more
practical and reliable process for both lenders and their clients than prescriptive
rules, such as a requirement to verify a client’s financial situation.
The law should recognise the difference between a client taking a margin loan for
the first time and an experienced margin loan client seeking an increase in their
credit limit and permit unsuitability tests to be calibrated accordingly.
The law should recognise standard business practices in the margin lending
industry in verifying information they receive on a client (ie avoid imposing
standards designed for other credit products).
There is a significant risk that a margin lender who makes inquiries to satisfy its
responsible lending obligations under the law may be considered to have given
personal advice. Therefore, it is essential that the definition of personal advice in
the Corporations Act is amended to eliminate this risk (as was done to remove
this risk for an entity conducting AML checks).
Statements of Advice (SOA)
The legislation must allow a margin loan provider to treat a loan as not being
unsuitable if the client has received an SOA recommending the margin loan from
a suitably qualified licensed financial advisor and the loan provider is not aware
of any reason to doubt the suitability of the advice.
A recognised certification process should be introduced to enable margin lenders
to readily access relevant client information in an SOA in a concise format.
An SOA issued within 90 days of the time of application should be acceptable for
these purposes.
Margin Call Notification
The Explanatory Memorandum should confirm that notification through the
following electronic means is acceptable - telephone, facsimile, SMS, email and a
client’s individual account accessed by the client logging into the lender’s
website.
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Periodic Statements
Clients should be properly informed of their margin loan position on a regular
basis. However, several aspects of draft reg 7.9.30B would be very difficult to
implement in practice and could increase risk for retail clients, rather than
reducing it as intended.
Better Targeted Law - Products
The margin lending legislation should be more finely targeted to clearly avoid
covering traded products, non-recourse loans and capital protected products.
ASIC Determinations and Guidance
ASIC’s determinations under the proposed law should apply prospectively only
and the law should set out the factors ASIC should consider in using its
determination power (including compliance costs).
ASIC should build on the understanding with industry developed during the
consultation process and consult to the greatest extent possible when considering
utilisation of its power or the provision of guidance to the market.
Further Consultation
This submission presents a wide range of matters that require attention in the
final drafting of the bill to be introduced into Parliament. AFMA would be happy
to meet with Treasury officers to discuss these issues or any other matters that
you feel we may be able to assist with. We understand the Government’s desire
to implement a regulatory regime for margin lending without undue delay and
would cooperate to help facilitate the speedy passage of legislation that will
provide effective regulation.
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2. Required Transition Period
It is evident from our analysis of the draft legislation in this submission that there
is a range of significant matters to be addressed before an acceptably efficient
form of regulation can be adopted. Thus, a transition period of 18 months will be
required to deliver the desired policy outcomes in an efficient and assured
manner for both margin loan providers and their clients.
The leading margin lenders in the Australian market are all based in banking
groups and regulated by both APRA and ASIC. They have strong, experienced
compliance and legal systems through which they can manage their new
obligations under the proposed regulatory regime.
Their existing business
operations benefit from the support of sophisticated operations divisions that are
designed to support a complex array of financial services.
Nonetheless, the extent of changes proposed, and consequently the length of
transition period required, depends on the Government’s decisions in respect of
the matters we raise in this submission. In addition, margin loan providers have
a range of other major regulatory reforms to implement over the next year or so,
including the unfair contract terms legislation and the national consumer credit
scheme. Even under the most optimistic scenario, it is not feasible to fully
implement the proposed margin lending regulation in the suggested timetable.
A non-exhaustive list of the matters that margin loan providers must address in
order to implement the regime and rough timelines from the passage of the final
legislation and regulations include:
New disclosure documentation
Margin lenders will have to review all documentation (this includes terms and
conditions, PDS, brochures, updated statements at minimum). In some
cases this will involve engagement with distribution partners, especially those
with whom the lender shares combined documents. This process will require
6 months as a minimum.
Chapter 7 compliance training
The new regime involves a reorientation of the loan issuance process from a
credit risk exercise to an unsuitability assessment task. While the outcomes
of the two process are broadly similar in terms of client outcomes (at or least
should be if the law is enacted in line with Treasury’s stated policy
intentions), it is still likely that all customer-facing staff, or client services
team members, will require formal training and certification to ensure
compliance with the new Chapter 7 obligations. This process will require at
least 12 months for completion.
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Unsuitability assessment
The new obligations will require the development and implementation of new
procedures, protocols and operating systems – it will take at least six months
to develop processes and credit requirements and at least 12 months to
implement any technology changes required for assessment/access to other
bank data. It is difficult to be precise about timelines in the absence of a
final definition of unsuitability.
Margin calls
The proposed margin call arrangements will involve change for some, if not
all, margin loan providers. Process changes (engineering, new client/agent
documentation, staff training and technology updates) will be necessary to
provide the required information. For example, it will be necessary to obtain
agreement with financial advisers on notification of affected clients. The
estimated implementation timeline is at least six months.
Distribution partner engagement
Overall, it could take at least 12 months to prepare partners. This includes
development and explanation of new disclosure documents and processes
described above. For example, it will be necessary to confirm that financial
advisers are meeting the new ‘responsible lending’ standard.
In addition to the above there is a range of other matters, such as variations to
Australian Financial Services (AFS) licences or applications for new licences and
review of external dispute resolution schemes, which will need to be attended to.
Further, all margin loan clients and financial advisors will need to be made aware
of the changes.
It is not uncommon for existing margin loans borrowers to seek credit limit
increases in order to meet their investment objectives, especially in a market
upswing. This effectively curtails the transition period for loan providers, as
many existing clients will not be grandfathered into the new regime, but rather
will have the new unsuitability test applied to them soon after its introduction.
Having regard to the above factors, we recommend that the Government should
engage industry on a reasonable transition timetable once there is clarity around
the final terms of the legislation that will be released for public consultation. On
the basis of the current draft legislation changes we do not believe it is feasible
to implement the required changes within a transition period of less than 18
months from the date that Royal Assent to the legislation is given. This should
include a six month transition period for licensing.
We note that the scope and scale of the changes required for margin loan
providers are in keeping with significant regulatory changes, such as the
introduction of the FSR regime, for which a 2 year transition period was granted.
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As Treasury is aware, the market practices currently adopted by key margin loan
providers are fundamentally sound. Moreover, the Government’s initiative in this
area has heightened lender awareness of the need to provide margin loans to
retail clients in a responsible manner with sensitivity to any operational risks that
a lender might have in this area. Thus, the transition period (including the 6
month licensing period) does not present an unacceptable regulatory risk.
Finally in relation to the transition period, it is also relevant to note that every
major piece of financial services law reform in recent years has necessitated
refinement measures subsequent to the passage of the main body of legislation
in order to make it effective in the manner intended. In this context, the new
margin lending regime will impact on a much broader range of financial services
than those covered by traditional margin loans (standard and non-standard). A
full assessment of the implications will necessarily be a gradual process (eg as
ASIC guidance is issued it may require financial services providers to reassess
the implications of the regime). Moreover, the current draft legislation suggests
that it will be necessary for regulatory relief to be granted through law change,
regulations or ASIC instruments in order for the measures to apply in a
reasonable manner that avoids unintended consequences. The transition period
we suggest will improve the prospect of serious problems being avoided and the
law being fully effective in the manner intended.
3. The Definition of Margin Lending
3.1. Client Declarations of Purpose
Section 761EA gives meaning to a range of definitions associated with a margin
lending facility. Section 761EA(2) provides a definition of a standard ‘margin
lending facility’, which has several constituent elements, one of which is that the
credit provided is, or may be, applied wholly or partly to acquire one or more
financial products, or a beneficial interest in one or more financial products.
(2) A standard margin lending facility is a facility under the terms of which:
(a) credit is, or may be, provided by a person (the provider) to another person
(the client); and
(b) the credit provided is, or may be, applied wholly or partly:
(i) to acquire one or more financial products, or a beneficial interest in one or
more financial products; or
The inclusion of the term “may be” introduces an element of ambiguity into the
scope of the definition to the extent that the application of funds provided to the
borrower under the loan is not in practice under the control of the lender and,
thus, they may or may not be applied for any particular purpose.
Margin loan providers wish to avoid the risk of having to straddle two regulatory
regimes for credit where the treatment depends on the use to which the loan
proceeds are put. The most practical way forward is for margin loan providers to
ask potential borrowers to explicitly confirm (eg by ticking a box), at the time
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they apply for a loan, that they will apply at least some of the funds provided
under the loan to purchase at least some marketable securities. This would be
similar to the business purpose declaration currently used in application forms.
The Explanatory Memorandum to the final Bill would offer greater certainty
around this point to issuers and investors by confirming that this approach is
adequate for the purpose of determining the margin loan status under the law of
a credit arrangement.
3.2. Scope of Purpose
Paragraph (b)(i) of the definition of margin loan does not limit its scope to a
great degree, as might be intended. This is because it is common for the
proceeds of a loan to be transferred to a client’s deposit account (ie a financial
product) before the funds are applied to their intended purpose.
3.3. Current LVR Definition – A Possible Regulatory Loophole
Section 761EA (3) states:
The current LVR of a standard margin lending facility at a particular time is the ratio,
percentage, proportion or level (however described) that:
(a) is determined under the terms of the facility; and
(b) under the terms of the facility, represents a particular relationship between:
(i) the amount of the debt owing by the client, or credit provided by the provider,
or both, under the facility at that time; and
(ii) the value of the secured property determined at that time under the terms of
the facility.
One reading of this provision taken with s.761EA(2)(c) is that there must be a
particular relationship between the amount of the debt owing by the client and
the value of all of the secured property, determined at that time, under the terms
of the facility for there to be a ‘current LVR’.
Thus, if a loan is designed such that the gearing ratio trigger event is determined
by reference to a subset of the secured property (albeit the predominant part of
the property), then there will not be a ‘current LVR’ within the terms of the draft
legislation and the product will not technically be a margin loan.
We have not had sufficient time to fully explore the extent to which this presents
a material legal risk to the regulatory regime being fully effective. However, it is
a matter that Treasury may wish to assess and explore further.
4. Required Product Exclusions from Margin Lending
Given the broad scope of the definition of margin lending, the final legislation
should define it to specifically exclude the categories of product outlined below:
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i.
Tradeable financial products – it is impossible for a product issuer to
conduct an unsuitability assessment on an instrument (eg an ASX listed
reset warrant) that is traded on a secondary market after it is issued, as
the issuer would be unaware of the details of potential buyers. These
products are usually derivatives and they are well-regulated under
Chapter 7 by ASIC and by ASX through its market rules. This part of the
industry has a strong record in delivering reliable products in a
responsible manner that has enabled retail investors to accumulate
wealth. It would be significantly impaired if a comprehensive exemption
is not granted.
ii.
Capital protected products and arrangements – there is no policy reason
to capture 100% capital protected products, as the client’s asset
acquisitions under the loan do not have downside price risk, which is the
risk to the retail investor that sits at the heart of the proposed regulation.
There is also a valid argument to exclude arrangements that offer the
client a high level of capital protection (eg >80%), as the level of risk
posed for the investor is substantially reduced and does not warrant
highly intrusive regulatory protection given the costs involved.
iii.
Non-recourse loans – it does not make sense to require a credit
assessment in relation to a non-recourse loan. Draft regulation 7.8.10(2)
is helpful but it is inadequate because it provides an exemption in relation
to the unsuitability test only, so the other margin loan retail obligations
would still apply. The borrower in a non-recourse loan cannot be enforced
against as a matter of law. The low level of risks involved provide a solid
policy case to simply exclude non-recourse loans form the definition of a
margin loan.
In making the above observations in respect of products that should be exempt
from the regime, we are cognisant of the fact that many products are already
adequately regulated as a financial products under Chapter 7 (eg instalment
warrants and protected equity loans are issued with a Product Disclosure
Statement) or they will be regulated under the proposed investment loan credit
regulation.
The Commonwealth’s assumption of responsibility for credit regulation means
that it will finally have to hand the full set of tools to deal effectively with the
long standing gap in regard to financial advice concerning borrowing
recommendations associated with a range of investments, whether or not they
are financial products. AFMA supports the public policy objective of ensuring that
there is no regulatory gap which precludes ASIC from investigating and taking
regulatory action in relation to the issuance of geared investments and financial
advice given in relation to them.
The form and detail of the integrated credit regulation regime is not yet fully
apparent, so it is difficult to provide comments on the interaction of margin
lending regulation with the other aspects, especially investment loan regulation.
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However, we note that it is important that redundant overlaps with current
regulation are not created and that margin lending fits within a rationally
designed system of regulation. In the context of the current draft legislation, this
means there is acceptable comfort that categories of products exempt under the
margin lending loan regulation will be properly regulated as a financial product or
credit product elsewhere in the regulatory system.
5. Impact of Margin Lending Regulation on Wholesale Markets
The policy rationale for the proposed changes to the Corporations Act as outlined
in the Minister’s public comments, the Commentary and the confidential
consultation process is based entirely on the need to enhance the consumer
protection measures for retail clients. AFMA supports the policy initiative in this
context.
With regard to the wholesale market, there is no evidence of a market failure
that warrants regulatory intervention and there has been no policy analysis to
support the application of these measures to the wholesale market. Indeed, the
key parts of the wholesale markets already fall within scope of existing
regulation.
The quality of this regulation and the sound performance of the OTC derivatives
markets, which would be brought within scope of the margin lending legislation,
has been acknowledged by the Government.
Last week, the Minister for
Superannuation and Corporate Law commented in response to the
ASIC/RBA/APRA survey of Australia’s OTC Derivatives markets; “The survey also
found Australian industry and participants reacted sensibly to the challenge of the
global financial crisis, by improving OTC processes and moving to reduce and
manage risks. This is a mature market response which should be positively
acknowledged.”
AFMA agrees with the Minister’s assessment and does not believe that there is a
basis to apply margin lending regulation to the wholesale market.
We note that a proper reflection of the retail/wholesale distinction is critical to
the effectiveness of the policy framework embedded in Chapter 7 of the Act. The
situation in the wholesale market must be separately assessed and a specific
decision made to impose an additional regulatory burden on wholesale margin
lending business.
The draft law would bring major wholesale business lines within the margin
lending regulatory regime, given the broad scope of margin lending definition.
For example:
•
The breadth of the definition of margin lending may pick up ISDA
documented collateral arrangements for derivatives as well as other
wholesale
transactions.
Encouraged
by
regulators,
collateral
11
arrangements in support of OTC derivatives transactions are increasingly
common, as credit conditions have tightened since the global financial
crisis.
For example, the ASIC/RBA/APRA survey of Australia’s OTC
markets recommended greater use of collateral to manage counterparty
credit risks. 1
•
Prime brokers are major international stockbrokers who provide a bundled
range of services and facilities to their clients. They are effectively a ‘one
stop shop’ for services like custody, trade execution, clearance and
reporting, as well as securities lending and financing. The provision of
finance to clients under prime broking arrangements may involve the
transfer securities from the client (borrower) to the broker (lender) under
a securities lending facility in return for cash. It seems likely that these
arrangements would fall under the definition of a non-standard margin
loan and, hence, be caught by the legislation.
•
Some general institutional financing arrangements that involved securities
lending would also fall within scope of margin lending. These transactions
are typically conducted under an Australian Master Securities Lending
Agreement (AMSLA) and generally the borrower is obliged to collateralise
its obligation to return equivalent securities. The collateral usually takes
the form of cash but it may also be other securities. Where collateral is
provided, both the value of the lent securities and the value of the
collateral are marked to market on a daily basis, and the borrower can be
required to provide extra collateral.
•
A range of other wholesale market transactions, including repurchase
agreements between the Reserve Bank and financial institutions may also
fall within scope of the definition of margin lending. Market practice in
response to price movements is for repurchase agreements to be repriced
or for collateral (or increased collateral) to be provided.
•
Business loans may also fall within scope of the measures: for instance a
loan to help restructure a company group that involves the purchase of
securities (eg in a partly owned subsidiary) that is secured in part by
securities or another financial product (including a deposit) and is subject
to covenants in relation to gearing would potentially be a margin loan
under the current definition.
The application of margin lending regulation to the wholesale market would have
the following effects:
•
Increased compliance costs for lenders who would have to obtain a
variation to the AFS licence and put in place procedures and resources to
manage the associated compliance obligations on an ongoing basis.
1
Australian industry participants are encouraged to expand, where practicable to do so, the use
of CSAs attached to Master Agreements and review the application of initial margin, unsecured
thresholds and minimum transfer amounts.
12
•
Overseas providers in the wholesale market who hold an AFS licence
exemption may be required to obtain a licence for their business in
Australia or else require law amendments or ASIC relief to avoid the
requirement to hold a licence for margin lending or alternatively they
could withdraw from the Australian market which would reduce liquidity
and harm market efficiency.
•
Greater legal risk, as the definition of margin lending is imprecise and
overlaps significantly with the existing financial product definition; the
regulatory implications of dealing inadvertently with retail clients is more
serious.
•
Increase costs for market users, as entities seek to recover the cost of
meeting a greater regulatory burden and spreads widen if liquidity is
affected (which depends on the policy response).
•
ASIC would have to licence a much wider range of market participants for
the margin lending regulatory regime than is currently anticipated. This
would complicate and lengthen the transition process. In addition, ASIC
could end up regulating a significant part of the business lending market,
which would detract some resources from its other responsibilities, like
consumer protection.
•
Australia would be regarded as a less competitive place to do business,
given the associated compliance costs and legal risks.
The Commentary (1.46) states that general ‘stock’ or securities lending,
particularly in the wholesale market, is not intended to be included in this
definition. It seems reasonable to assume that the legislation is not intended to
cover other wholesale business either and we would agree with that approach.
AFMA recommends that the definition of margin loan should cover only loans to
retail clients. This approach would achieve the stated policy purpose and neatly
avoid unnecessary interference in wholesale markets, which are generally
covered by existing regulation anyway (as many wholesale arrangements caught
are already financial products and margin loans in the traditional sense are not a
notable feature of our wholesale financial markets).
At a minimum, the final legislation should state that if a product being provided
to a wholesale client is both an existing financial product (eg a derivative) and a
margin loan (as defined under s.761EA), then it will be treated as a financial
product only (ie not as a margin loan) for the purpose of the law.
6. Definition of Wholesale Client for Margin Lending
Section 761G of the Act explains when a financial service or product is provided
to a retail client and a wholesale client it prescribes a number of tests for making
the distinction. AFMA supports the proposed approach, which is to apply the
general tests (including the income and asset tests) in s.761G to margin lending
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arrangements. We also note that a transaction value/price test provides a bright
line transaction test that can be a useful operational devise to reduce regulatory
compliance costs for financial services providers, though setting the appropriate
dollar amount for the test presents a challenge.
The key matter for further consideration here is the appropriate price threshold
for the purpose of subsection 761G(7)(a) of the Act. Draft regulation 7.1.19A
specifies an amount of $500,000 for this purpose, with the price to be calculated
by reference to the value of the equity provided by the client.
We consider the proposed regulation to be consistent with the approach taken in
regulations 7.1.18 and 7.1.19 for investment based financial products, which
specify an amount of $500,000, excluding any amounts lent by the person
offering the product. The required equity contribution of $500,000 represents a
significant financial commitment by the investor to the margin loan arrangement
before it can be classified as a loan to a wholesale client.
We note that there are situations where an individual may use a number of
entities to manage their business, family or financial affairs. For example, a
margin loan borrower may offer shares held by company that they control as
security for their margin loan. In our view, it would be in keeping with the intent
of the law (as reflected, for example, the aggregation rule in reg 7.1.17B) to
treat an individual in this circumstance as a wholesale client, provided the equity
contribution supporting the loan satisfies the $500,000 threshold test.
We believe it is appropriate to require a significant financial commitment of at
least this order for a client to be treated as a wholesale client. However,
members have observed that it is difficult to prescribe an amount for the equity
contribution or margin loan amount that will achieve the desired regulatory
outcome in differentiating retail and wholesale client with complete certainty.
7. Making the Unsuitability Assessment
Margin lenders are required to make an assessment in order to determine
whether a loan is unsuitable for a ‘retail client’. Members have expressed a
number of concerns with the draft legislation that need to be addressed before it
is finalised.
7.1. Distinguish between New Loans and Limit Increases
The law should adopt a risk based approach to regulation and especially the
conduct of unsuitability assessments. There is a fundamental practical difference
between a margin loan client taking a loan for the first time and an experienced
margin loan client seeking an increase in their credit limit. The law should be
written to provide flexibility for margin loan providers to operate in a manner that
responsibly reflects the relative risks.
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The draft law is deficient in this regard because it does not distinguish between
new applications and credit limit increases. It is pertinent that other parts of the
Corporations Act recognise the relevance of investor experience for the purpose
of determining a licensee’s obligations to a client.
Moreover, the draft law may deliver undesirable outcomes for clients. For
example, they will not be able to take advantage of market opportunities that
they identify in a timely manner if there is a delay in granting a credit limit
increase due to the requirement to conduct a full unsuitability test. In other
instances, a lender may be forced to fail a trade for a client because they have
inadvertently breached their credit limit by a small amount. This disadvantages
the client and is harmful from a market efficiency perspective.
Having regard to the time available to respond with comments on the draft
legislation, we recommend that Treasury should consult further on the manner in
which the law might be recalibrated to deliver the flexibility require for an
effective risk based approach to regulation.
7.2. Recognition of Margin Lending Business Practices
Margin lenders ordinarily make inquiries into a prospective client’s financial
situation and their understanding of margin loans, both to test the
creditworthiness of the client and to support a sound client relationship. Hence,
a regulatory obligation requiring a lender to conduct this form of analysis could
be implemented efficiently if the associated law is drafted appropriately. This
reflects the prudential imperative for lenders to contain credit risk within
acceptable bounds, which serves to protect the borrower to a significant degree,
as both they and the lender share a common interest in the loan contract being
fulfilled without undue difficulty.
The Commentary (1.64) explains that lenders are not expected to take action
going beyond “standard business practice” in verifying the information they
receive. This approach seems to accord with the desired policy outcome, as we
understand it from the consultation process.
However, it is not clear if the standard business practices for verification referred
to in the Commentary relates specifically to margin loans or to credit in general.
Practices vary from one type of credit product to another, reflecting the particular
characteristic of the facility and the credit risks involved. For example, providers
of home loans undertake extensive verification checks of income and assets
having regard to the size of the loan, the particular sensitivity to home loan
delinquency and the borrower’s capacity to repay it. However, margin lenders
typically adopt a higher level assessment, having regard to the marketable
nature of the security offered, the gearing level and size of the loan in question.
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The imposition of standard business practice designed for other credit products
on margin lending would be inappropriate and potentially very costly for loan
providers and their clients (for example, involving loan application fees for clients
of over $500). This would be an unintended outcome because the direct sales
channel has not been the source of concerns that has motivated the regulation of
standard margin loans and regulation should aim to have a competitively neutral
outcome between business models. Therefore, the legislation or the associated
Explanatory Memorandum must be clear that the intended benchmark is the
standard business practice for margin lending.
In addition, the legislation must allow for the fact that standard business practice
will evolve over time to reflect changes in technology, operations, management,
prudential expectations and commercial experience in this area over time.
Therefore, it is not appropriate to prescribe particular practices in legislation
(which would be practically difficult to do in any event).
7.3. Verification of Client Income
The practical operation of the law would be considerably improved without
compromising the underlying policy objective if the requirement in s.985F(2)(b)
were modified to state that the lender must, before making an assessment, take
reasonable steps to verify the retail client’s income. This is a better targeted
requirement that the current draft, as ‘financial situation’ is an imprecise and
open concept that, consequently, is difficult to implement. The alternative
wording has greater precision and is more feasible from a practical perspective.
That said, we question the need for prescriptive measures in this area because
an effective risk based approach to assessing unsuitability should deliver a more
practical and reliable process for both lenders and their clients.
7.4. Reliance on Information Provided by the Client
There appears to be a disconnect between the policy intent presented in the
Commentary (1.64), which states that a margin loan provider may rely on
information provided to it by its client in accordance with standard business
practice and the law [s.985F(1)(B)] which requires reasonable steps to be taken
to verify the client’s financial situation.
We believe that if a client presents information to a potential margin loan
provider, the provider should be able to take this information at face value, as
the client should have a responsibility to declare the information it provides to be
honest and accurate.
Nonetheless, margin loan providers must undertake
additional steps to check the information provided in order to mange the credit
risk exposure they have to the borrower. The effect of the process as a whole is
to sufficiently protect the interests of both the lender and its client.
16
Margin lending is a reasonably high volume business, so it is important to
preserve the efficiency of the business model by avoiding a situation where a
credit officer is required to review, verify information and assess each application
for a loan or a limit increase. The transaction delays and costs involved would
not be in the interests of the client or its adviser. Standard business practices
include the use of automated credit assessment systems and the proposed
regulatory regime should recognise the relevance and adequacy of these systems
for margin lending.
7.5. Restrictions on Availability of Internal Bank Information to the Margin
Lender
Full service banks offer a broad range of financial products and services (eg
deposits, home loans, credit cards, and securities broking) and in the course of
this business they collect a broad range of personal information from clients.
This information is obtained by relevant business units and is not accessible by
the margin lending business unit as a matter of course for regulatory and other
reasons. There are many situations where regulation recognises the separation
of business units from other parts of an entity (eg Chinese walls to manage
conflicts of interest).
For certainty, the margin lending legislation should be amended to make it clear
that the margin loan provider can make an unsuitability assessment of a client by
reference only to the information provided by the client in the course of the loan
application process (or from an eligible statement of advice). This approach
would provide a satisfactory level of protection to the client, preserve business
operating efficiencies and ensure that clients are treated in the same manner
whether they deal with a specialist margin loan provider or a full service bank.
7.6. Testing Unsuitability – Timing
Section 985G requires the margin loan provider to investigate the loan
applicant's circumstances "at the time of the assessment". It is not practically
feasible for a lender to do this because, at best, the information necessary to
make an assessment will be current as at the time of application for the loan (or
limit increase) but not at the actual time of the assessment. Any documents that
a margin loan provider requests in order to assess unsuitability are likely to be
historical (eg audited balance sheet, pay slip etc).
The law should be amended to make it clear that a margin loan provider can
adopt a practical approach to compliance and may rely on historical data where it
is reasonable to do so having regard to the impossibility of obtaining real time
information on loan applicants.
In addition, we note that section 985G does not limit the situations in which a
loan could be unsuitable, but rather sets out when they must be unsuitable.
17
7.7. Extent of Reliance on Clients Assets
The Commentary (1.58) states that the general position is that clients should be
able to meet their contractual obligations from income and available liquid
assets, rather than from long-term savings or from equity in a fixed asset such
as a residential home. “In particular, the ability of clients to service the margin
loan must not be dependent on the returns that are potentially available from the
portfolio financed by the loan.” This proposition is not supported by the draft
legislation and we believe its application would lead to inferior consumer
protection and investment outcomes.
We understand that the intention is for the Commentary to remind margin loan
providers that, when assessing the unsuitability of a loan for a client, they should
take a prudent approach in assessing the likelihood of income being generated by
the loan security portfolio. We agree with this approach and recommend that the
Explanatory Memorandum should be written to give clear guidance on this point.
Similar comments may be made in respect of the reference in the Commentary
(1.58) to reliance on long term savings and fixed assets, which would also be
unduly restrictive if read in a narrow, prescriptive manner. In reasonable
circumstances, these assets could be taken into account when making enquiries
about the unsuitability of a loan for a client and the client may expect a lender to
do so. Again, the Explanatory Memorandum could be more carefully worded than
the Commentary to remove doubt in this regard.
As a general rule, it would be inappropriate for a borrower or lender to entirely or
substantially depend on the returns that are potentially available from the
securities financed by the loan to service the margin loan or to rely on long term
savings to meet likely obligations under the loan contract. It is reasonable to
assume a conservative level of income will be generated by a share portfolio and
that this could be applied to help service the loan. Some investment products,
like certain deferred purchase agreements, offer a coupon return (which may be
guaranteed) that should automatically be factored into the client’s available
income for servicing the loan. In other cases, the security portfolio may include
property or other components that can reasonably be relied up to provide income
to help services the loan.
It would be counterproductive for the law, or ASIC in its associated guidance, to
require that a margin loan provider must ignore or excessively discount the
income stream likely to be generated from the assets financed by the loan. The
effect could be to encourage investors to minimise the amount of their share
portfolio that is held as security for the margin loan arrangement, as the
associated income would not be recognised as being available to service the loan.
Investors would be more inclined to maximise their gearing level (and, hence
risk) under the margin loan given the proposed requirement.
18
It is good business practice for lenders to make prudent assumptions about the
level and volatility of incomes flows, like dividends, from securities held under a
loan. However, this does not mean that lenders should discount them entirely
for the purpose of credit and unsuitability assessments.
Having regard to the uncertainty created by the Commentary, the Explanatory
Memorandum should explicitly confirm that margin loan providers should adopt
prudent assessment practices when considering their clients’ ability to service
margin loans. While the Explanatory Memorandum may make reference to
matters to be considered, it should clarify in doing so that these are indicative
factors rather then determinative pronouncements in any given situation.
8. Client Access to Unsuitability Assessments
Section 985H gives clients the right to request the margin loan provider to
provide them with a written copy of the unsuitability assessment. AFMA accepts
there are reasons why a client should be given this access; however, we do not
believe the proposed timeframe is realistic from a practical perspective.
If the client makes a request after the arrangements are finalised, the copy must
be provided within 2 business days and failure by the lender to comply with a
request incurs a civil penalty that is a strict liability offence. Since the client’s
request may be received up to 12 months after the day the margin loan is
terminated, there may often be a 5 year gap or more between the date the
assessment was made and the date that the client’s request is made.
The proposed 2 business day obligation is inadequate given the time periods
involved. If assessments are held in storage off-site, some lenders would require
at least 7 business days notice.
We do not believe it unreasonable to expect a client to wait for 7 business days,
if many years have elapsed since they entered the margin loan transaction. We
cannot foresee any circumstances where the client would have a critical need to
access the assessment within shorter time period ie the client will not be making
an investment decision on the basis of the assessment.
9. Substantial Hardship
The term substantial hardship is not defined in the draft legislation, nor is there
any guidance on its meaning. The absence of clarity about the intended scope of
the term as it applies to margin lending creates uncertainty and risk for lenders.
At a minimum, the draft legislation should be amended to increase certainty by
stating that the sell down of any or all of marketable securities held as security
19
under the margin loan arrangement does not, of itself, represent substantial
hardship. 2
More generally, recognition has to be given to the fact that the law is not
designed (and cannot practically be designed) to eliminate cases of hardship to
margin loan borrowers. However, law that promotes responsible behaviour by
lenders and borrowers is feasible and it will reduce the probability of these events
occurring. Thus, the fact that a substantial hardship case occurs in a particular
circumstance is not indicative of a flawed unsuitability assessment process.
Nonetheless, in the event that a client subsequently suffers substantial hardship
consequent to a margin call, there is a risk that the margin lender may be
considered prima facie to have conducted a faulty unsuitability assessment.
Unsuitability under the proposed test is necessarily a matter of judgement at the
time a loan is granted, so the retrospective assessment of this judgement after a
client has suffered hardship poses very significant risk to lenders (even though
they conduct their business in a responsible manner).
The nature of the
unacceptable risk is further evident by the nature of the judgement that must be
made at the time a loan is proposed. Market conditions regularly change,
reflected in share price movements, volatility, market liquidity, confidence and a
range of other factors, so a margin lender must make assumptions about the
capacity of a client to meet their obligations under the loan under a range of
possible market outcomes. This is a probability based exercise, so what might be
considered ‘possible’ will vary from time to time and (because it involves
judgement) from one person to another.
Hence, the challenge for a third party to conduct an objective analysis of a
lender’s decision some years ago is significant. The associated risk might be
ameliorated through the provision of principles that promote objectivity in the
retrospective judgement of margin loan assessments in situations where hardship
is encountered. These principles might refer to specific matters such as:
• Market behaviour (eg historical volatility);
• Market conditions and indicators;
• Standard industry practices in margin lending;
at the time the relevant margin loan (or increased limit) was granted.
We recognise the practical challenge in precisely defining substantial hardship.
However, the associated risk might be ameliorated if the Explanatory
Memorandum provides principles to promote objectivity in the retrospective
judgement of margin loan assessments.
2
Paragraph 1.72 of the Commentary merely states that a “sell-down of part of the portfolio”
does not imply substantial hardship.
20
10.
Unsuitability Tests and Personal Advice
It is vital that the law does not create a situation where a margin lender is at risk
of being considered to have given personal advice under the law, merely because
it has made inquiries to satisfy its responsible lending obligations under the law.
In particular, we think it essential that the law is clear that a lender who makes
inquiries to satisfy s.985F will not inadvertently be treated as giving personal
financial advice (eg where they are given access to a client’s SOA and make a
suitability assessment utilising some of the information therein).
Margin lenders have to inquire into aspects of the financial situation of clients
when making an unsuitability assessment. This inevitably involves being given
access to some personal information of the client (unless reliance is able to be
placed on an SOA, where relevant professional advice has been received by the
client). There is a significant risk that some retail clients will interpret the
assessment as personal advice (indeed, some may ask to be provided with the
assessment), or consider the assessment to have a wider application to other
financial products or services (eg “If a margin loan is suitable for me, then
product X must also be suitable, as it’s similar in many respects”). This will
heighten the risk that a margin loan provider will be found to have offer personal
advice within the technical terms of the law.
The desired certainty for margin loan providers and their clients can be achieved
by making an amendment to the definition of personal advice in s.766B(3) of the
Corporations Act, similar to that made to avoid actions taken to comply with the
Know your Customer rules of the Anti-Money Laundering and Counter-Terrorism
Financing Act 2006 being treated as personal advice. 3 We strongly recommend
that this amendment is made, which would be in keeping with the stated policy
intent of margin loan regulation.
11.
Information Provided in a Statement of Advice
Section 985F(3) permits a margin loan provider to rely on information provided
in a SOA in specified circumstances. AFMA agrees that this form of reliance
should be acceptable. However, we have a number of comments to make below
in relation to the manner in which SOA information should be treated in the
legislation. The approach in the draft legislation risks creating a lack of clarity
and understanding about the separate roles of lender and adviser, with a
resultant duplication/overlap in obligations and confusion on the part of clients.
At a minimum, a margin loan recommendation in an SOA should be treated as
prima facie evidence that the loan is not unsuitable.
3
Section 766B(3) - For the purposes of this Chapter, personal advice is financial product
advice that is given or directed to a person (including by electronic means) in circumstances
where: (a) the provider of the advice has considered one or more of the person's objectives,
financial situation and needs (otherwise than for the purposes of compliance with the AntiMoney Laundering and Counter-Terrorism Financing Act 2006 or with regulations, or AML/CTF
Rules, under that Act).
21
11.1.
Extent of Reliance on a Statement of Advice
The final legislation must allow a margin loan provider to treat a loan as not
being suitable for a client if the client has received an SOA recommending the
margin loan from a licensed financial advisor who is qualified to provide advice on
margin loan products and services and the loan provider is not aware of any
reason to doubt the suitability of the advice.
If the law does not do this, it will impose a significant and needless cost on many
investors and margin loan providers, apparently to limit the liability placed on
financial planners for advice they have given.
A financial advisor who provides an SOA is giving personal advice to their client,
which the client would reasonably expect to be able to rely on. SOAs can run
into many hundreds of pages and they are typically based on a much broader
array of information about the client than is required for the purpose of giving
advice on margin lending alone.
Section 945A(1) of the Act requiring that there is a reasonable basis for the
advice puts in place a suitability rule that the licensee must adhere to in
providing personal advice on a margin loan (or other financial products and
services). This is complemented by specific margin loan measures in Regulation
7.7.09AA requiring a licensee providing advice to a retail client concerning
margin loans to include in the SOA information in relation to the special matters
prescribed by subsection 985F(1)(c). This is intended to cover the matters that
are considered to contain particular risks to margin loan borrowers, and which
should therefore be carefully considered by lenders and advisors before providing
or recommending a margin loan. Thus, the obligations placed on licensed
financial planners in proving advice to retail clients in relation to margin loans are
significant and should adequately protect the client.
Having regard to the above, it seems extraordinary to deny a margin lender the
ability to rely on a SOA that recommends a margin loan to a client for the
purpose of meeting the unsuitability test – and in doing so to impose significant
additional costs on retail investors.
We emphasise that the improvement we suggest would not transfer responsibility
for conducting the responsible lending test to the financial planner; rather it
would enable the lender to use advice given in the SOA more effectively (and in
keeping with its practical intent) when making a judgement on the unsuitability
of the loan. Of course, the financial planner would remain responsible for the
suitability test it conducts in relation to the client under s.945A(1) and the
associated provisions and regulations (including Regulation 7.7.09AA).
Making margin lending a Chapter 7 financial product will bring associated advice
within the scope of the Financial Services Regulation (FSR) regime. We believe
22
that the structure of the FSR regime is fundamentally sound and it provides the
necessary scope of actions to ensure that future financial advice is provided in a
competent and fair manner.
It would be contrary to the principles of efficient regulation to duplicate suitability
tests or to impose a responsible lending obligation on margin lenders with the
intention that this should serve as a safety net to catch poor advice from licensed
financial planners. However, this would seem to be the intent of the law as it is
currently drafted.
11.2.
Certification
As mentioned above, SOAs are substantive documents, containing confidential
information and can run for several hundreds of pages or more. Margin loan
providers do not have the capacity to review the full documents given the
number of existing and new clients they must deal with (in some cases tens of
thousands of clients). Moreover, margin loan providers would not want to be
placed in a position of being on notice of all the information in a SOA, much of
which may not be relevant to a recommendation to advice on a margin loan or a
decision about its suitability. Thus, they may not accept SOAs in the absence of
an efficient and low risk process to extract relevant information from them. Were
this to happen due to the proposed regulation it would significantly increase costs
for clients and lead to greater duplication in services provided to them.
At the very least, a recognised certification process should be introduced to
enable margin lenders to readily access relevant information in an SOA in a
concise form that is efficient to use. The certificate should be prepared by the
financial planner and summarise the relevant information on the client it has
relied on in preparing the SOA:
i.
ii.
iii.
Income;
Assets;
Liabilities (including other loans).
If a SOA contains a recommendation in relation to a margin loan, the certificate
should also:
iv.
v.
State the recommendation given in the SOA;
Confirm that the general unsuitability assessment required under Chapter
7 of the Corporations Act and the specific requirements in Reg 7.7.09A
have been conducted by the financial planner in accordance with the law.
11.3.
Timing Issues
Section 985F(3)(b) requires that the SOA being considered by the margin lender
must have been prepared no more than 30 days before the loan is entered into
(or the limit is proposed to be increased). We believe this is unnecessarily
restrictive and would impose a needless cost on clients if the information verified
23
by the SOA must be collected again and verified again by the margin loan
provider. AFMA recommends that an SOA issued within 90 days of the time of
application should be acceptable and an older SOA should be acceptable if the
adviser confirms to the lender that he/she has reviewed the client’s situation and
nothing has caused him/her to change the information in that document since the
time of issue.
In addition, the final legislation should clarify that the (30 or 90 day) period
should be assessed at the time that the client provides a completed loan
application, which is when the unsuitability assessment begins. There is often a
short delay between the loan application being received and it being approved, or
potentially a longer delay between the application being made or approved and
funds being drawn down under the loan (eg because the client waits until they
consider market conditions suitable for their investment).
12.
Margin Lending Disclosure Regime
Effective disclosure of product characteristics, including associated benefits, cost
and risks, is a central element of consumer protection. While comment has been
made on the good quality of existing standards of disclosure for standard margin
loans, the proposed regulatory regime should ensure that minimum standards
are met on an ongoing basis by all margin loan providers over time.
In this context, we note that the margin lending disclosure regulations for the
short from Product Disclosure Statement (PDS) are being developed and we look
forward to their release in draft form for consultation.
However, one aspect of disclosure that members are unclear about is the
intended treatment of joint products PDSs – for example, where a PDS might
cover a margin loan facility and the underlying shares which the loan funds will
be applied to purchase. Investors benefit from the convenience of a single
document in the form of a joint PDS that covers all relevant issues in relation to
their geared share purchase. We expect the intention is that this form of
disclosure will be permitted on a short form basis, but require further guidance
from the Government to confirm this point.
In addition, there needs to be flexibility to allow for a PDS and FSG to be
combined and for a margin lending PDS to be combined with another financial
product PDS – again to preserve the efficiency and usefulness of the disclosure to
retail clients.
13.
Notification of Margin Calls
AFMA supports the approach adopted in s.985L requiring that margin lenders
must take reasonable steps to notify the client of a margin call as soon as is
practicable. If a share price were to collapse (as happens on occasion), this
24
approach will enable positions to be closed quickly and protect the financial
interests of both lenders and their clients.
Section 985L provides that the notification must be given in a manner agreed
between the parties, or, if there is no such agreement, in a manner determined
by ASIC. The Commentary clarifies that this notification could occur by electronic
means. AFMA believes this approach will support cost effective and timely
notification of clients when a margin call occurs.
We recommend that the Explanatory Memorandum to the final legislation should
confirm that notification through the following electronic means:
•
Telephone call,
•
Facsimile,
•
SMS,
•
Email,
•
A client’s individual account accessed by the client logging into the
lender’s website (in effect a customised messaging system).
It should be sufficient for the purposes of the legislation, where this form of
notice is agreed between the lender and its client, as it is the most efficient
method of notification for both clients and lenders.
14.
Periodic Statements
The draft legislation includes amendments to the Corporations Act to ensure that
margin loan providers must provider periodic statements to borrowers. AFMA
supports this approach as we believe clients should be properly informed of their
margin loan position on a regular basis. However, it makes sense to apply the
provisions to the margin loan only, not to the uses to which the loan proceeds
are applied.
We agree with the comment in the Commentary that the information required in
periodic statements generally under s.1017D(5) is largely relevant to investment
products rather than lending. Therefore, it makes sense to adopt a regulation
prescribing information particular to margin lending facilities, to supplement the
general requirements in the Act. However, we are very concerned that several
aspects of draft reg 7.9.30B would be very difficult to implement in practice and
could increase risk for retail clients, rather than reducing it as intended.
14.1.
Loan Termination Value
Section 1017(5)(b) requires inclusion in the periodic statement of the termination
value of the investment at the end of the reporting period to the extent that it is
reasonably practical to do so. While a loan may enable a client to make an
25
investment, the loan itself is not in the nature of an investment (rather it is in the
nature of a credit arrangement, which is quite different). Therefore, we do not
believe s.1017(5)(b) is relevant to a margin loan and we recommend that the
Explanatory Memorandum should be written to confirm that this is the case for
avoidance of doubt.
There are a number of practical factors that support this outcome. As a matter
of course, banks provide borrowers with regular updates on their loan balance
and the associated interest rate is transparent, so borrowers have sufficient
information to manage their financial affairs. Some clients may have fixed
interest rate loans, for which a charge may be incurred if the loan is terminated
early (depending on relative interest rates).
It would place a significant
regulatory burden on margin loan providers if they were required to provide each
and every fixed interest client (ie many thousands of clients) with the cost of
early termination of their loan. 4 Rather, banks offer fixed interest borrowers a
facility by application to obtain the cost of early termination of their loan. Since
investors ordinarily plan to hold their loan until maturity, this approach provides
a sensible and responsible way to service the information needs of clients.
14.2.
Provision of Asset Valuations – A New Lender-Client Relationship
We have a fundamental concern about the role in which the lending institution
would be placed. In effect, reg 7.9.30B would require the margin lender to
provide a comprehensive portfolio valuation service to the borrower. Several
issues follow in addition to those identified above:
•
This would be a departure from accepted loan contract arrangements and
create a much broader commercial and legal relationship between the
margin lender and its clients;
•
Lenders would be open to considerable risk, as clients may take action
outside of the margin loan arrangement in response to the valuations
provided by the lender (eg a client may spend funds on consumer good
and services on the understanding that their assets are more valuable);
•
Lender do not have the internal resources necessary to value the potential
range of assets offered by clients on an ongoing basis;
•
The cost of valuing all assets in an acceptably precise manner on a regular
basis would be very large, would have to be borne by the borrowers and
would offer little regulatory benefit beyond that available through the
valuation of marketable securities only.
We can see no policy basis to mandate the provision of a portfolio valuation
service by a margin loan provider to its clients. Moreover, the precedent
established by regulation 7.9.30B would be of great concern to the broader
4
For example, it would be necessary to obtain a quote from the bank’s treasury division in
relation to the interest cost of terminating each margin loan.
26
banking industry (eg would home loan providers be required to provide
borrowers with regular valuations of their residential property?).
14.3.
Provision of Asset Valuations – Creating New Risks for Retail Clients and
Lenders
Historic information is of limited value for clients in trying to monitor their margin
loan facilities as margin call risks are prospective in nature. In this context, we
believe the imposition of a requirement for margin loan providers to give
borrowers regular valuations would be both unnecessary and risky because:
i.
The valuation is unlikely to be accurate when it is received by the
borrower (eg due to changes in market conditions);
ii.
It may mislead retail clients – because the valuation is given by the holder
of an AFS licence, a retail client is more likely to assume it is accurate,
although it may be imprecise (eg lenders over unlisted managed funds
may have to rely on third party data that they cannot verify);
iii.
Even if the market valuations are correct at the time they are made, they
are not the prices at which the assets can be liquidated subject to the
terms of the margin loan;
iv.
Investors should receive valuation information independently of the
margin loan on their assets - either from ASX or from the issuer of the
financial product in question.
It has been suggested during consultations that margin loan providers might
avoid these problems by including disclaimers on the periodic notification
statements; for example, stating that the valuations have been prepared for the
purpose of the assessing security rather than assessing the actual market value
of the security. However, this approach is fraught with risk.
For example, notwithstanding the disclaimer ATO places on its product rulings,
the media has reported that tax experts are concerned that retail investors may
have mistaken ATO product rulings on agricultural schemes for unofficial
assurance of the commercial viability of the investment.
ATO Assistant
Commissioner Bruce Collins is quoted as saying “We say it again and again and
again. I think it’s very clear that investors should get their own independent
advice. The ATO is not in the business of providing any opinion on an investment
or any investment projections.” Nonetheless, it appears that some investors
have misunderstood the nature of ATO’s product guidance and there is every
reason to suspect that some investors may not take account of disclaimers given
by licensees who provide valuations of margin loan security.
Therefore, we believe it would be unwise to require margin lenders to provide the
asset valuations proposed in reg 7.9.30B(d) and would argue that this should be
deleted from the regulation.
27
If the law, nonetheless, prescribes that a security valuation is to be provided,
then it should be given on an aggregate basis in percentage terms, rather than
on an itemised basis. For example, “we have calculated your LVR on 30 June
2009 at 45%.” This would communicate a sufficient level of information to the
client about the value of their security in relation to the loan and would
ameliorate to some extent the risks identified above.
14.4.
Practical Problems
Paragraph (d) of regulation 7.9.30B raises significant practical problems, in
addition to the serious policy concerns outlined above.
Paragraph (d)(1) requires the market value of each item of security “to the
extent that a market valuation is available and reasonably ascertainable”. There
is no guidance on the intended threshold for determining if a market valuation is
“reasonably ascertainable”. While there will generally be an observable price for
securities listed on the Australian Securities Exchange (ASX) or another
exchange, the availability and reliability of prices for other assets offered as
security is a matter that is open to interpretation.
If a market valuation is not available and reasonably ascertainable for an item of
property, then Paragraph (d)(2) requires the lender to provide “a valuation of the
item that is based on a methodology that is appropriate in the circumstances”.
Again, there is no obvious basis upon which to determine what an appropriate
methodology is for a particular asset (eg commercial property, a residential
investment property, or an asset like a collectible item) and there is no guidance
given. In practice, lenders may seek greater security if the assets offered are
difficult, which overcomes the need to value all assets precisely.
These interpretational concerns are not a trivial matter and will generate
significant uncertainty. For example, Treasury would be aware that there has
been much inquiry into the meaning of terms like “generally available” and
“readily observable” in the context of the insider trading provisions in Part 7.10 of
the Corporations Act. Therefore, if the valuation requirements are to be retained
in the regulation, it is important for the Government to provide guidance on the
intended scope of the terms, including both positive and negative examples.
14.5.
Conventional Loans that are Unconventional Margin Loans
Periodic statements are designed with mainstream margin loans in mind and do
not take account of more regular loans that will be captured by the legislation.
This will affect banks and other financiers more so than stockbrokers who have a
narrower business interest in margin loans.
It may help to illustrate the issue by way of an example. Assume a small
business (ie a retail client) obtains a loan from a bank to finance its working
capital. The loan proceeds will be transferred to a deposit account (ie margin
28
loan purpose test met). The bank takes a charge over the company’s assets,
which may include debentures, as security for the loan (ie margin loan security
test met). The loan terms include a covenant in relation to the gearing level
between assets given as security and liabilities (ie margin loan LVR test met). 5
Thus, a business loan may be subject to margin loan regulation.
Since the business assets over which the charge is held may include equipment,
machinery and various other forms of real property as well as marketable
securities, the loan provider would be required to value a vast array of assets to
meet its obligation under draft reg 7.9.30B. This would present a challenge that
would often be impossible to meet in practice and present an enormous burden
on banks as lenders to address on a best endeavours basis.
Ordinarily, a bank would not seek to value all real property assets held as
security, given the inherent difficulty in valuing them, but rather may require the
borrower to provide certified valuations. Alternatively, a bank might take a
significant haircut on the security held to compensate for the difficulty in
estimating a market value due to the nature of the asset or its price volatility.
If banks are required to issue valuations for a range of real assets, they are likely
to be conservative and may present risks to directors of the borrowing company,
especially if they are not healthy.
In reality, banks would avoid taking
marketable securities as loan security, or avoid a gearing constraint altogether,
which places a different type of regulatory cost on lenders and borrowers.
In summary, there is no policy basis for margin lending regulation to interfere in
credit intermediation for business in this manner. Leaving to one side the
definitional issues relating to margin loans as it applies to such business loans,
this illustrates the inappropriateness and impracticality of the proposed periodic
statements in some circumstances.
15.
ASIC Determinations and Guidance
ASIC is granted considerable power under the draft legislation.
Under section 761EA(9) ASIC may declare a facility to be a margin lending
facility. It is necessary to deal with product innovation and the likelihood that
over time new margin loan structures will evolve that may not be captured by the
current definition. This is in the interests of both margin lenders and their retail
clients.
However, the draft legislation is too open ended as it provides no guidance to
ASIC in respect of the matters it should consider in making a determination. This
5
The draft law, s.761EA(3)(ii), is not clear on whether the LVR must be calculated by reference
to some or all of the assets offered by the borrower as security (it refers to “the secured
property”. The example could apply in either case.
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creates uncertainty about the potential application of the law. This should be
resolved by requiring that ASIC’s determinations apply prospectively only and by
providing the necessary guidance on the use of the determination power within
the legislation (eg ASIC should have regard to the following matters in making a
determination; X, Y, Z). 6 This approach is taken in other areas of the law where
an agency is given discretionary power.
In addition, the law should not close off mechanisms through which any ASIC
determinations might be open to review in the event that a provider believes
they are unfairly disadvantaged by an ASIC determination. 7
ASIC can determine the time and manner that notification of a margin call is to
occur [s.985L(3)]. ASIC will also provide guidance where appropriate to set out
further detail about reasonable inquiries and verification in particular
circumstances. ASIC’s utilisation of these powers, which deal with the key
operational aspects of margin lending, will have an important bearing on the
compliance cost for implementing the new regulatory regime. We recommend
that the law should contain a provision requiring ASIC to consult with industry
before utilising its power in this part of the Act [with the exception of section
761EA(9)] and to have regard to compliance cost in using its powers. Often the
injection of industry experience into regulation design can reduce compliance
costs, while still achieving the targeted regulatory outcome.
Finally, the legislation should not include any provisions to restrict ASIC’s ability
to grant exemptions and modifications in respect of the margin lending provisions
under the power granted to it in Division 5 of Part 7.11 of the Corporations Act.
The Explanatory Memorandum should refer to the ASIC’s capability in this regard.
16.
Other Issues
Licensing in a Securitisation Context
There is not clarity about the requirement to be licensed as a margin lender in all
circumstances. An example brought to our attention in this regard is where a
margin loan provider securitises part of their loan book. Securitisation involves
assigning loans to another party who becomes the lender, although the loan
continues to be serviced by the originator. There is a view that the existing
framework may work using the intermediary exemptions, but clarity on this point
would be helpful.
To illustrate this, assume Company A is a broker, Company B is the initial lender
and servicer and Company C a securitisation trust. Company B would retain
6
For example, see s.230-405 in the Taxation Laws Amendment (Taxation of Financial
Arrangements) Bill 2008, which set out matters the Commissioner of Taxation must have
regard to in making certain determinations.
7
Part 9.4A of the Corporations Act is relevant here.
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some loans but generally assign loans to Company C. In this case, it can be
argued that Company A could be the licensed entity for margin lending purposes.
That is, A offers the financial product and B is the issuer.
*****
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