The rules of engagement around margin loans have changed, for lenders and advisers alike. Su-King Hii examines the key issues.
The Corporations Legislation Amendment (Financial Services Modernisation) Act 2009 ushers in a new regime for margin lending products, as part of the Labor Government’s plan to regulate consumer credit nationally.
The effect of the legislation is to treat margin lending facilities as a form of financial product under the Corporations Act, meaning that providers and advisers of such facilities are subject to licensing, disclosure and responsible lending requirements.
Existing issuers and advisers on margin lending facilities who did not apply to the Australian Securities and Investments Commission (ASIC) for a variation of their licences before June 30, 2010 must not advise on, and deal in such products until they are licensed or authorised to do so. The balance of the requirements such as disclosure, suitability assessment and responsible lending obligations will commence on January 1, 2011. Financial planners who advise on, and deal in, margin lending facilities must:
• be aware of the requirements and make adequate preparations;
• review the internal guidelines to ensure full compliance; and
• undertake the necessary training.
Features of a margin lending facility
Generally speaking, a margin lending facility allows an investor to borrow to invest in financial products against the security of any equity contribution, usually in the form of financial products. It is common for advisers to recommend margin lending facilities to their clients as part of the financial planning process (wealth creation strategy), and they are generally offered to investors who wish to increase the size of their investment portfolios, boost investment returns and accelerate wealth creation in a tax-effective manner.
The Act classifies margin lending facilities into standard and non-standard facilities.
Standard facility
A standard facility is one where:
• credit is provided to a natural person, and the credit is applied wholly or partly to acquire a financial product; and
• the credit provided is, or must be, secured by property which consists, wholly or partly of one or more marketable securities; and
• the client becomes required to, or the provider or another person becomes entitled to, take action in accordance with the terms of the facility where the current Loan to Valuation Ratio (LVR) of the facility exceeds a ratio, percentage, proportion or level determined under the terms of the facility.
Non-standard facility
A non-standard facility is a facility under the terms of which:
• a natural person transfers one or more marketable securities to the provider of the facility;
• the provider transfers property to the client which is, or must be applied wholly or partly to acquire one or more financial products; and the client has a right, in the circumstances determined under the terms of the facility, to be given marketable securities equivalent to the transferred property given to the provider; and
• the client becomes required to, or the provider or another person becomes entitled to take action in accordance with the terms of the facility where the current LVR of the facility exceeds a ratio, percentage, proportion or level determined under the terms of the facility.
Under the ASIC definition, a non-standard margin lending facility is
“…intended to target those arrangements that are not based on a loan agreement, but instead use a type of securities lending agreement (with variations) to achieve a similar economic outcome as would a standard margin lending facility.” (Note1)
This type of structure was used by lenders such as Opes Prime Stockbroking and Tricom Equities up until 2008.
One important point to remember is that the margin loan regulatory regime will only apply to loans:
• made to a natural person; and
• that are used partly or wholly for the purchase of financial products – meaning that the use of the loan for such purpose must form part of the margin lending facility.
The new regime will not apply to general business lending; nor will it capture loans used solely for personal, domestic or household use.
The standard margin lending facility is by far the more common form of facility. Typically, the margin lending facility provider would prescribe a certain level of LVR, and the level of LVR will vary with the particular marketable securities, which will be determined by the lender from a risk and liquidity perspective. Where the value of the underlying securities decreases to the level below the agreed contract (margin), a margin call will occur where the client will have to either “top up” the margin loan account, provide the lender with additional securities, or liquidate the position. Margin lenders usually have the right to liquidate the client’s position if certain action is not taken by the client.
Reasonable inquiries and suitability assessment
One of the fundamental requirements in relation to the issuing of a margin lending facility or the increase of limit is the requirement to undertake an assessment of the suitability of the facility for the retail client (the suitability assessment). The provider must, within 90 days before issuing (or increasing the limit of) the facility, assess whether it will be unsuitable for the client. In order to undertake the suitability assessment, the provider must make reasonable inquiries about, and take reasonable steps to verify, the client’s financial situation.
In the Explanatory Memorandum to the Bill, it states:
