Implementation of the National Margin Lending Regime - Essay Example

ASIC Policy on Margin Lending & Revisions Made The Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 is an amendment to the Corporations Act 2001, and has the main purpose of setting a national regulatory framework for margin loans. (Parliament of Australia, 2009) With respect to margin loans, the main changes made by the Amendment were to Chapter 7 of the Corporations Act, so that lenders and advisors in ‘margin lending facilities’ will be required to hold an Australian Financial Services License with specific conditions. (Stone, 2009) The Amendment also includes new regulations regarding responsible lending and notification of clients when there is a margin call. Under Chapter 7 of the Corporations Act 2001, standard and non-standard margin lending facilities are defined in terms of lending for the purposes of obtaining ‘financial products’, and authorises ASIC to define what is or is not a margin lending facility, and define what LVR (loan-to-value ratio) designates the margin call limit for that kind of facility. (“Corporations Act 2001”, 2001) Margin loans are actually just one issue addressed by the amendment; other provisions include placing promissory notes valued at $50,000 under the same regulations as debentures and establishing a public register of debenture trustees, and transferring the regulation of trustee companies from the states and territories to the Commonwealth. (Parliament of Australia, 2009) The specific regulatory changes made by ASIC with respect to margin lending resulting from the Amendment are in the areas of training standards for financial advisors and financial resource requirements for margin lending facilities. (Australian Securities & Investment Commission, 2010) In the area of training standards, ASIC defines a shortcoming in the Corporations Act in that the obligations on those who are required to obtain an AFSL are expressed as “high-level principles,” and are not specific enough. For example, representatives of companies with an AFSL are required to be adequately-trained and competent in the kind of business being done, but what that means exactly is not described. While ASIC expresses the opinion that the competitive nature of the financial services industry probably does lead to high standards in training and competence, there is no guarantee of this, and no way before the regulatory changes for customers to objectively judge the qualifications of the people with whom they are considering doing business. (Australian Securities & Investment Commission, 2009) The change made in the policy on training requirements was in the classification of margin lending facilities. Training requirements have always differed depending on the level of complexity of the financial products involved: Tier 1 products include managed investments, securities, derivatives, and superannuation, i.e., products that are investment-based and are exposed to market volatility; Tier 2 products are simpler, and include ordinary banking activities and things like debit cards. Correspondingly, training requirements for Tier 1 products are more stringent than for the latter. (Australian Securities & Investment Commission, 2009) The problem in this was that margin lending facilities were not clearly defined as being under either category. Therefore, “adequate training” and “competence” of advisors in margin lending businesses could have been equally satisfied by either Tier 1- or Tier 2-level training. This of course would lead to confusion for customers because of varying standards from one facility to the next. After consultation, the solution by ASIC was to place margin-lending facilities under Tier 1 for training purposes, which increases the qualifications needed for advisors and makes the standards uniform for all margin lenders. In addition to better describing the training requirements, there are two other significant changes brought about by the Amendment with regard to margin lending. First, there are stricter requirements for assessing the credit of customers before making margin loans, to prevent customers from taking on loans that they cannot afford. Specifically, the lender must ensure that the customer has sufficient resources to cover the loan in case of a margin call, must determine if any of the equity contribution made as security for the loan has been obtained with other loans (double-gearing), and whether any residential property is included in the equity contribution. (Stone, 2009) If the answer is no in the first case or yes for either of the other two, then a margin loan should not be offered to the customer, and there are penalties assessed by ASIC for doing so. The second significant change is to add a third category to margin-lending facilities. The provisions of Chapter 7 of the Corporations Act 2001 already allow ASIC to regulate ‘standard’ and ‘non-standard’ margin-lending facilities, as described above (“Corporations Act 2001”, 2001), but under the Amendment there will be a third, which is best described as what ASIC deems to be a margin-lending facility on a case-to-case basis. The rationale for this is to anticipate innovations in financial products, so that they can be properly regulated without necessarily requiring another time-consuming change in the law. (Stone, 2009) How the Revisions Address Issues in Margin Lending The revisions are some improvement to the regulatory regime for margin lending facilities, but do not completely answer all the problems that have been revealed by the financial crisis. On the positive side, bringing margin-lending facilities fully within the area covered by Chapter 7, instituting new rules for disclosure, credit assessment, training requirements, and licensing limits the number of margin-lenders to those companies and agents who are, theoretically anyway, better able to manage margin lending safely and responsibly. One of the problems margin lending created in the recent financial crisis is that so many had become involved in it; in 2008, there were over 202,000 clients and more than $32 billion in margin loans outstanding in Australia. (DLA Phillips Fox, 2009) The reason that became a serious problem is because of the volatility in the stock market, and the rapid changing of the values – downwards, in most cases – of the stocks underlying many of the margin loans. Margin calls to customers led to their selling off of the underlying stocks, which in turn reduced the stock values even further. On the other hand, the new regulations that have the practical effect of limiting the number of margin lenders do not affect a large number of companies; ASIC gives varying estimates of between 10 and 15 active margin lenders in Australia at present, and as many as a half-dozen of those are companies that fall under the regulatory scrutiny of APRA and not ASIC, and so are not necessarily affected by the revisions. (Australian Securities & Investment Commission, 2009) Something else that the revisions do not seem to address directly is the practise of using their own shares as loan collateral by company directors. Even under normal conditions, the disclosure of this activity would cause an increase in trading volume and an ‘artificial’ impact on the company’s share value. In the case of a margin call, which did happen to some high-profile directors such as Eddy Grove from ABC Learning Centres, the sale of the shares to cover the call could create serious loss of value and stability for the company. (DLA Phillips Fox, 2009) It may be that the ASIC regulation of margin lending might not be the appropriate regulatory regime to completely answer that problem, but how it could be separated from the other requirements for better assessment of customers’ credit standing is not really clear, either; it would seem to be a related issue. In addition, there are possible problems in the requirements for lending to retail clients. The new regulations explain that “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’” (Stone, 2009), but what exactly constitutes a ‘substantial hardship’ is not defined. Thus, the possibility that customers could still ‘get in over their heads’ with margin calls exists. Even though the lender is required to make certain the customer is adequately able to meet a margin call and can be penalised for not doing so, it is still a judgment left to the lender. In a case where a customer encounters ‘substantial hardship’ and defaults as a result of a margin call, the lender can make a defence against being penalised by simply pointing out that the same judgment was used for this particular customer as for others who did not encounter the same problem, and since there is no guidance to the contrary from ASIC, the lender cannot be said to have intentionally overlooked something. Along those same lines, there is not yet a specific credit limit for margin lending, although the government is seeking feedback on whether there should be one. (Stone, 2009) Imposing definite limits would further reduce the risk of defaults, because it would avoid the confusion that arises from the ‘substantial hardship’ problem. Preventing the use of their own shares for margin loans by company directors, making more specific definitions applicable to assessment of customer creditworthiness, and setting clear credit limits are additional revisions that should be added to the ASIC guidelines to fully-solve the potential issues involved with margin lending. References Australian Securities & Investment Commission. (2009) “ASIC implementation of the national margin lending regime”. ASIC, December 2009. [Internet/PDF document] Available from: . Australian Securities & Investment Commission. (2010) “09-242AD Information for issuers and advisers of margin lending facilities”. ASIC, 7 December 2009. [Internet] Updated 12 January 2010. Available from: . “Corporations Act 2001”. (2001) Commonwealth Consolidated Acts. [Internet] Available from: . DLA Phillips Fox. (2009) “Margin Lending – Issues 2009”. Financial Services & Revenue Update, March 2009. [Internet] Available from: . Parliament of Australia. (2009) “Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009”. Parlinfo Search, n.d. [Internet] Available from: . Stone, Phillipa. (2009) “Overhaul of margin lending regime – how will it impact margin lenders?” Freehills Patent & Trade Mark Attorneys, 13 May 2009. [Internet] Available from: . Read More